**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

ý    **QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedSeptember 30, 2005**

 

**or**

 

o    **TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                      to                     .**

 

**Commission File Number 000-50405**

 

**ACUSPHERE, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                  | ** ** | **04-3208947**                    |
|-----------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of incorporation |       | (IRS Employer Identification No.) |
| or organization)                              |       |                              |
|                                          |       |                              |
| **500 Arsenal Street**                        |       |                              |
| **Watertown, Massachusetts**                  | ** ** | **02472**                         |
| (Address of principal executive offices)      |       | (Zip Code)                        |

 

Registrant’s TelephoneNumber, Including Area Code: **(617) 648-8800**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes o No ý

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b 2 of theExchange Act.  Yes oNo ý

 

As of November 7, 2005there were 21,780,902 shares of the registrant’s common stock, $.01 par valueper share, outstanding.

 

 

 

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** **

**ACUSPHERE, INC.**

 

**Form 10-Q**

**For the Quarterly Period Ended September30, 2005**

 

**CONTENTS**

 
| ** **                                                                                         |
|----------------------------------------------------------------------------------------------------|
| PART I: FINANCIAL INFORMATION                                                                      |
| Item 1. Consolidated Financial Statements                                                          |
| Condensed Consolidated Balance Sheets:                                                             |
| September 30, 2005 (Unaudited) and  December 31, 2004                                              |
| Condensed Consolidated Statements of  Operations (Unaudited):                                      |
| Three and Nine Months ended September 30,  2005 and 2004                                           |
| Condensed Consolidated Statements of Cash  Flows (Unaudited):                                      |
| Nine Months ended September 30, 2005 and  2004                                                     |
| Notes to Condensed Consolidated Financial  Statements (Unaudited)                                  |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operation |
| Item 3. Quantitative and  Qualitative Disclosure about Market Risk                                 |
| Item 4. Controls and Procedures                                                                    |
| PART II: OTHER INFORMATION                                                                         |
| Item 1. Legal Proceedings                                                                          |
| Item 2. Changes in  Securities, Use of Proceeds and Issuer Purchases of Equity Instruments         |
| Item 3. Defaults Upon Senior Securities                                                            |
| Item 4. Submission of Matters to a Vote  of Security Holders                                       |
| Item 5. Other Information                                                                          |
| Item 6. Exhibits                                                                                   |
| Signature                                                                                          |

 

 

2

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**PART I: FINANCIAL INFORMATION**

**ITEM 1. CONSOLIDATED FINANCIALSTATEMENTS**

 

**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                                                                               | ** ** | **September 30,  2005** | ** **  | **December 31,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                               | ** ** | ** **              | ** **  | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                               |       |                    |        |                   |       |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                                                                          |       |                    |        |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                |       | $                       | 59,947,381  |                   | $          | 45,179,915 |   |
| Other current assets                                                                                                                                                                                                                                                                                                                                     |       | 806,124                 |        | 2,096,681              |       |
| Total current assets                                                                                                                                                                                                                                                                                                                                     |       | 60,753,505              |        | 47,276,596             |       |
| PROPERTY AND EQUIPMENT,  at cost:                                                                                                                                                                                                                                                                                                                        |       |                    |        |                   |       |
| Property and equipment (Note 5)                                                                                                                                                                                                                                                                                                                          |       | 48,148,481              |        | 20,876,140             |       |
| Less accumulated depreciation and amortization                                                                                                                                                                                                                                                                                                           |       | 9,845,286               |        | 8,006,819              |       |
| Property and equipment, net                                                                                                                                                                                                                                                                                                                              |       | 38,303,195              |        | 12,869,321             |       |
| OTHER ASSETS                                                                                                                                                                                                                                                                                                                                             |       | 1,784,369               |        | 1,857,306              |       |
| TOTAL                                                                                                                                                                                                                                                                                                                                                    |       | $                       | 100,841,069 |                   | $          | 62,003,223 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                           |       |                    |        |                   |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                                                                     |       |                    |        |                   |       |
| Current portion of long-term obligations (Note 7)                                                                                                                                                                                                                                                                                                        |       | $                       | 5,884,373   |                   | $          | 1,071,627 |   |
| Current portion of deferred revenue (Note 8)                                                                                                                                                                                                                                                                                                             |       | 3,428,571               |        | 3,428,571              |       |
| Derivative liability (Note 9)                                                                                                                                                                                                                                                                                                                            |       | 1,690,275               |        | —                 |       |
| Accounts payable                                                                                                                                                                                                                                                                                                                                         |       | 1,992,944               |        | 4,237,934              |       |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                         |       | 5,788,754               |        | 4,396,020              |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                                                |       | 18,784,917              |        | 13,134,152             |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                                                                                   |       |                    |        |                   |       |
| Long-term obligations, net of current portion                                                                                                                                                                                                                                                                                                            |       | 12,893,316              |        | 2,502,579              |       |
| Deferred revenue, net of current portion                                                                                                                                                                                                                                                                                                                 |       | 1,285,715               |        | 857,143                |       |
| Total long-term liabilities                                                                                                                                                                                                                                                                                                                              |       | 14,179,030              |        | 3,359,722              |       |
| COMMITMENTS                                                                                                                                                                                                                                                                                                                                              |       |                    |        |                   |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                                                                               |       |                    |        |                   |       |
| Preferred stock, $0.01 par value per share  Authorized - 5,000,000 shares as of September 30, 2005 and December 31, 2004  Designated 6.5% convertible exchangeable - 1,000,000 shares as of September  30, 2005 and none as of December 31, 2004 Issued and outstanding — 900,000  shares as of September 30, 2005 and none as of December 31, 2004 |       | 9,000                   |        | —                 |       |
| Common stock, $0.01 par value per share Authorized -  98,500,000 shares as of September 30, 2005 and December 31, 2004 Issued and  outstanding 21,408,943 shares as of September 30, 2005 and 17,810,922 as of  December 31, 2004                                                                                                                        |       | 214,089                 |        | 178,109                |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                               |       | 276,574,724             |        | 221,672,237            |       |
| Deferred stock-based compensation                                                                                                                                                                                                                                                                                                                        |       | (467,873                | )           | (914,492               | )          |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                      |       | (208,452,823            | )           | (175,426,505           | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                                                                          |       | 67,877,121              |        | 45,509,349             |       |
| TOTAL                                                                                                                                                                                                                                                                                                                                                    |       | $                       | 100,841,069 |                   | $          | 62,003,223 |   |
|                                                                                                                                                                                                                                                                                                                                                          |            |                         |             |                        |            |  |  |  |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

3

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**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** **  | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                  | ** ** | **September 30,**      | ** **  | **September 30,**     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                  | ** ** | **2005**               | ** **  | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                        |       |                   |        |                  |       |   |   |   |   |
| COLLABORATION REVENUE                                       |       | $                      | 857,143     |                  | $          | 857,143 |   | $ | 2,571,429 |   | $ | 857,143 |   |
| OPERATING EXPENSES:                                         |       |                   |        |                  |       |   |   |   |   |
| Research and development                                    |       | 8,855,734              |        | 5,784,879             |       | 31,760,682 |   | 17,580,297 |   |
| General and administrative                                  |       | 1,747,217              |        | 1,513,384             |       | 5,608,340 |   | 4,462,429 |   |
| Total operating expenses                                    |       | 10,602,951             |        | 7,298,263             |       | 37,369,022 |   | 22,042,726 |   |
|                                                        |       |                   |        |                  |       |   |   |   |   |
| Interest income                                             |       | 458,925                |        | 148,673               |       | 1,290,266 |   | 350,207 |   |
| Other (expense) income                                      |       | —                 |        | (6                    | )          | - |   | 74,262 |   |
| Interest expense                                            |       | (404,052               | )           | (26,187               | )          | (886,716 | ) | (101,298 | ) |
| Change in valuation of  derivative                          |       | (19,618                | )           | —                |       | 1,367,725 |   | — |   |
| NET LOSS                                                    |       | $                      | (9,710,553  | )                     | $          | (6,318,640 | ) | $ | (33,026,318 | ) | $ | (20,862,412 | ) |
| Dividends on preferred  stock (Note 9)                      |       | (731,250               | )           | —                |       | (1,763,040 | ) | — |   |
| NET LOSS AVAILABLE TO  COMMON STOCKHOLDERS                  |       | $                      | (10,441,803 | )                     | $          | (6,318,640 | ) | $ | (34,789,358 | ) | $ | (20,862,412 | ) |
| NET LOSS AVAILABLE TO  COMMON STOCKHOLDERS PER SHARE — |       |                   |        |                  |       |   |   |   |   |
| Basic and diluted                                           |       | $                      | (0.58       | )                     | $          | (0.39 | ) | $ | (1.95 | ) | $ | (1.40 | ) |
| WEIGHTED-AVERAGE SHARES OUTSTANDING —                  |       |                   |        |                  |       |   |   |   |   |
| Basic and diluted                                           |       | 17,915,403             |        | 16,155,990            |       | 17,852,280 |   | 14,917,465 |   |
|                                                             |            |                        |             |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

4

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**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(unaudited)**

 
| ** **                                                                   | ** ** | **Nine Months Ended** | ** **  |
|------------------------------------------------------------------------------|------------|-----------------------|-------------|
| ** **                                                                   | ** ** | **September 30,**     | ** **  | **September 30,** | ** ** |
| ** **                                                                   | ** ** | **2005**              | ** **  | **2004** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                       |       |                  |        |   |   |
| Net loss                                                                     |       | $                     | (33,026,318 | ) | $ | (20,862,412 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                  |        |   |   |
| Stock-based compensation expense                                             |       | 463,919               |        | 702,211 |   |
| Depreciation and amortization                                                |       | 1,838,467             |        | 942,100 |   |
| Write-off of intellectual property acquisition cost,  net (Note 6)           |       | 5,218,132             |        | — |   |
| Noncash interest expense                                                     |       | 510,040               |        | 38,689 |   |
| Noncash rent expense                                                         |       | 383,001               |        | 116,401 |   |
| Noncash amortization of deferred revenue                                     |       | (2,571,428            | )           | (857,143 | ) |
| Noncash amortization of fee and warrants to  financial advisor               |       | 201,780               |        | — |   |
| Change in valuation of derivative                                            |       | (1,367,725            | )           | — |   |
| Changes in operating assets and liabilities:                                 |       |                  |        |   |   |
| Deferred revenue                                                             |       | 3,000,000             |        | 5,000,000 |   |
| Other current assets                                                         |       | 1,036,456             |        | (52,834 | ) |
| Accounts payable                                                             |       | (2,244,990            | )           | 797,217 |   |
| Accrued expenses                                                             |       | 770,164               |        | 707,640 |   |
| Net cash used in operating activities                                        |       | (25,788,496           | )           | (13,468,122 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                       |       |                  |        |   |   |
| Purchases of property and equipment                                          |       | (27,272,341           | )           | (6,601,787 | ) |
| Increase in other assets                                                     |       | 72,937                |        | (82,500 | ) |
| Net cash used in investing activities                                        |       | (27,199,404           | )           | (6,684,287 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                       |       |                  |        |   |   |
| Payments on long-term obligations                                            |       | (1,730,169            | )           | (720,031 | ) |
| Proceeds from long-term obligations                                          |       | 11,497,367            |        | 731,913 |   |
| Net proceeds from sale of common stock in private  placement                 |       | 17,565,921            |        | 16,519,646 |   |
| Net proceeds from sale of preferred stock                                    |       | 41,887,416            |        | — |   |
| Payment of preferred stock dividends (Note 9)                                |       | (1,519,290            | )           | — |   |
| Net proceeds from exercise of stock options                                  |       | 15,987                |        | 71,603 |   |
| Proceeds from issuance of common stock from employee  stock purchase plan    |       | 38,135                |        | 24,448 |   |
| Net cash provided by financing activities                                    |       | 67,755,367            |        | 16,627,579 |   |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                        |       | 14,767,466            |        | (3,524,830 | ) |
| CASH AND CASH  EQUIVALENTS — Beginning of period                        |       | 45,179,915            |        | 54,562,378 |   |
| CASH AND CASH  EQUIVALENTS — End of period                              |       | $                     | 59,947,381  |   | $ | 51,037,548 |   |
|                                                                              |            |                       |             |  |  |  |  |  |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

5

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**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**1.****              Basisof Presentation**

 

The accompanyingunaudited condensed consolidated financial statements of Acusphere, Inc. andSubsidiaries (the “Company”), have been prepared in accordance with generallyaccepted accounting principles in the United States of America for interimfinancial information and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by generally accepted accounting principles in the UnitedStates of America for complete financial statements. These statements should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s latest audited annual financial statements.Those audited statements are included in our Annual Report on Form 10-K for theyear ended December 31, 2004, which has been filed with the SEC.

 

In the opinion ofmanagement, all adjustments, consisting only of normal, recurring adjustmentsconsidered necessary for a fair presentation of the results of these interimperiods have been included. The results of operations for the three and ninemonths ended September 30, 2005 may not be indicative of the results that maybe expected for the full fiscal year.

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of expenses during the reporting period.Actual results could differ from those estimates or assumptions. 

 

**2.****              RevenueRecognition**

 

The Company recognizesrevenue from license arrangements in accordance with Staff Accounting BulletinNo. 104, “Revenue Recognition” (“SAB 104”) and FASB Emerging Issue Task ForceIssue No. 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables” (“EITF 00-21”). The Company recognizes revenue from licensepayments not tied to achieving a specific performance milestone ratably overthe period over which the Company is obligated to perform services. The periodover which the Company is obligated to perform services is estimated based onavailable facts and circumstances. The Company recognizes revenue fromperformance payments, when such performance is substantially in the Company’scontrol and when the Company believes that completion of such performance isreasonably probable, ratably over the period over which the Company estimatesthat it will perform such performance obligations. Substantive at-riskmilestone payments, which are based on achieving a specific performancemilestone when performance of such milestone is contingent on performance byothers or for which achievement can not be reasonably estimated or assured, arerecognized as revenue when the milestone is achieved and the related payment isdue, provided that there is no substantial future service obligation associatedwith the milestone. Revenue in connection with license arrangements isrecognized over the term of the arrangement and is limited to payments collectedor due and reasonably assured of collection. In circumstances where thearrangement includes a refund provision, the Company defers revenue recognitionuntil the refund condition is no longer applicable unless, in the Company’sjudgment, the refund circumstances are within its operating control andunlikely to occur.  Payments received inadvance of being recognized as revenue are deferred.

 

**3.****              Accountingfor Stock-based Compensation**

 

The Company’s employeestock option plans are accounted for using the intrinsic-value-based method ofAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations. Accordingly, no compensationexpense is recorded for options issued to employees with fixed amounts andfixed exercise prices which for accounting purposes are at least equal to thefair value of the Company’s common stock at the date of grant. Conversely, whenthe exercise price for accounting purposes is below fair value of the Company’scommon stock on the date of grant, a non-cash charge to compensation expense isrecorded ratably over the term of the option vesting period in an amount equalto the difference between the value calculated using the exercise price and thefair value. The Company uses the fair-value method to account for non-employeestock-based compensation.

 

6

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Stock options grantedduring 2005 are as follows:

 
| ** **                   | ** ** | **Number  of  Shares** | ** ** | **Exercise  Price  Per Share** | ** **  | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
|------------------------------|------------|------------------------|------------|--------------------------------|-------------|---------------------------------------------------|------------|
| For the three months  ended: |       |                   |       |                           |        |                                              |       |
| March 31, 2005               |       | 847,500                |       | $                              | 5.43 - 6.30 |                                              | $          | 5.83 |   |
| June 30, 2005                |       | 221,100                |       | $                              | 4.28 - 5.35 |                                              | $          | 4.85 |   |
| September 30, 2005           |       | 174,400                |       | $                              | 5.56 - 6.00 |                                              | $          | 5.84 |   |

 

The stock options grantedin the three and nine months ended September 30, 2005 were granted at fairmarket value on the date of grant.

 

Had compensation cost forgrants issued during the current and prior periods been determined consistentwith Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accountingfor Stock-based Compensation,” pro forma net loss available to commonstockholders and net loss per share available to common stockholders would havebeen the following:

 
| ** **                                                                            | ** ** | **Three Months Ended**  | ** **  | **Nine Months Ended**   | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------|-------------|-------------------------|------------|
| ** **                                                                            | ** ** | **September 30,  2005** | ** **  | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Available to common stockholders:                                                     | ** ** | ** **              | ** **  | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss — as reported                                                           |       | $                       | (10,441,803 | )                       | $          | (6,318,640 | ) | $ | (34,789,358 | ) | $ | (20,862,412 | ) |
| Add: Stock-based employee compensation expense  included in reported net loss         |       | 111,953                 |        | 193,234                 |       | 376,746 |   | 583,276 |   |
| Deduct: Stock-based employee compensation expense  determined under fair value method |       | (528,426                | )           | (456,405                | )          | (1,576,059 | ) | (1,328,619 | ) |
| Net loss — pro forma                                                             |       | $                       | (10,858,276 | )                       | $          | (6,581,811 | ) | $ | (35,988,671 | ) | $ | (21,607,755 | ) |
| Net loss per common share (basic and diluted):                                        |       |                    |        |                    |       |   |   |   |   |
| As reported                                                                           |       | $                       | (0.58       | )                       | $          | (0.39 | ) | $ | (1.95 | ) | $ | (1.40 | ) |
| Pro forma                                                                             |       | $                       | (0.61       | )                       | $          | (0.41 | ) | $ | (2.02 | ) | $ | (1.45 | ) |
|                                                                                       |            |                         |             |                         |            |  |  |  |  |  |  |  |  |  |  |

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123R, Share-BasedPayment (“SFAS No. 123R”). This Statement is a revision of SFASNo. 123, Accounting forStock-Based Compensation, and supersedes Accounting Principles BoardOpinion No. 25, Accounting forStock Issued to Employees, and its related implementation guidance.  SFAS No. 123R focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions. The Statement requires entities to recognizestock compensation expense for awards of equity instruments to employees basedon the grant-date fair value of those awards (with limited exceptions). Inaccordance with a recently-issued rule by the SEC, SFAS No. 123R iseffective as of the beginning of the first annual reporting period that beginsafter June 15, 2005.  The Companyexpects to adopt SFAS No. 123R on January 1, 2006 using the Statement’smodified prospective application method. The Company does not yet have an estimate of the effect on itsstatements of operations of adopting SFAS No. 123.

 

**4.****              NetLoss Per Common Share**

 

Basic and diluted netloss per common share is calculated by dividing the net loss available tocommon stockholders by the weighted-average number of unrestricted commonshares outstanding during the period. Diluted net loss per common share is thesame as basic net loss per common share, since the effects of potentiallydilutive securities are antidilutive for all periods presented. Antidilutivesecurities, which consist of convertible exchangeable preferred stock, stockoptions, warrants, and restricted common 

 

7

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stock that are not included in the diluted net lossper share calculation, aggregated 10,851,371 and 3,006,755 as of September 30,2005 and 2004, respectively.

 

The following tablereconciles weighted-average common shares outstanding to the shares used in thecomputation of basic and diluted weighted-average common shares outstanding:

 
| ** **                                                           | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                           | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Weighted-average common shares outstanding                           |       | 17,917,911              |       | 16,164,010              |       | 17,855,868 |   | 14,927,069 | ** ** |
| Less weighted-average unvested restricted common  shares outstanding |       | (2,508                  | )          | (8,020                  | )          | (3,588 | ) | (9,604 | ) |
| Basic and diluted weighted-average common shares  outstanding        |       | 17,915,403              |       | 16,155,990              |       | 17,852,280 |   | 14,917,465 |   |

 

**5.****              Propertyand Equipment**

 

Property and equipment atcost consist of the following:

 
| ** **                                      | ** ** | **As of:**              | ** ** | ** **             | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** | **Estimated  Useful Life** | ** ** |
| Equipment                                       |       | $                       | 18,771,491 |                   | $          | 10,279,147 |   | 3 - 5 years | ** ** |
| Furniture and fixtures                          |       | 287,962                 |       | 188,252                |       | 5 years |   |
| Leasehold improvements                          |       | 604,158                 |       | 171,277                |       | Lease term |   |
| Sub-total depreciable assets                    |       | 19,663,611              |       | 10,638,676             |       |   |   |
| Less: accumulated depreciation and amortization |       | (9,845,286              | )          | (8,006,819             | )          |   |   |
| Total depreciable assets, net                   |       | 9,818,326               |       | 2,631,857              |       |   |   |
| Deposits on equipment purchases                 |       | 2,376,590               |       | 6,774,256              |       | N/A |   |
| Construction in progress                        |       | 26,108,279              |       | 3,463,208              |       | N/A |   |
| Total property and equipment                    |       | $                       | 38,303,194 |                   | $          | 12,869,321 |   |   |   |
|                                                 |            |                         |            |                        |            |  |  |  |  |  |

 

Deposits on equipment purchases represent progress payments forlong-lead time capital equipment purchases, the majority of which areassociated with development and expansion of the Company’s manufacturingoperations for AI-700.  The Company hasentered into an agency procurement agreement with a contractor covering thepurchase of equipment in connection with the build-out of the Tewksburyfacility.  As of the date of this report, the total estimated value ofequipment to be purchased under this agreement is $4.3 million, of which $3.9million was paid as of September 30, 2005, with the remaining$.4 million to be paid in Q4 2005.

 

Construction inprogress amounts represent costs incurred through September 30, 2005 for thebuild-out of the Company’s commercial manufacturing facility in Tewksbury,Massachusetts.  The Company has enteredinto an engineering and construction management services agreement with ParsonsCommercial Technology, Inc., as last amended September 29, 2005, authorizingParsons to perform on behalf of the Company, during the period ending December31, 2005, engineering, design and construction management services inconnection with the build-out of the commercial manufacturing facility inTewksbury, Massachusetts.  The totalvalue of this cost-plus percentage fee type contract is $25.8 million of which$22.2 million was paid on or before September 30, 2005. The build-out of thefacility is substantially complete, with minor items remaining to be addressedby the contractor. The Company expects that its total payments for substantiallycompleting the remaining items, excluding equipment purchases, will beapproximately $4.1 million in excess of the amounts that the Company hasalready paid through September 30, 2005, or approximately $500,000 in excess ofthe current contract value. We expect to begin amortizing the leasehold improvementsassociated with the build-out of our Tewksbury facility in Q4 2005.

 

**6.****              IntellectualProperty**

 

The Company expensesas “intellectual property costs” those amounts paid for in obtaining licenserights and patents rights to technology or products for which technologicalfeasibility has not been commercially demonstrated and no alternative futureuse has been shown to exist.  No amount has been capitalized by theCompany relating to the costs of intellectual property developed or acquired bythe Company.

 

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On May 11, 2005, theCompany entered into a Patent Transfer Agreement with ScheringAktiengesellschaft (“Schering”) pursuant to which the Company acquired rights,title and interest in certain ultrasound-related patents from Schering. Inconsideration of the transfer and assignment of these patents, the Companyagreed to pay Schering a total of $7.0 million of which $1.0 million was paidin May 2005, $3.0 million is due in May 2006, and $3.0 million is due in May2007. Because the Company has not demonstrated technological feasibility or analternative future use for these patents, the present value of this acquisitioncost, $6.2 million, was expensed at the time of acquisition, with the remainingpayments recorded as liabilities on our consolidated balance sheet.  See also Note 7.  The balance of this acquisition cost, $0.8million, is recorded as noncash interest expense amortized ratably through May2007.  During the three and nine monthsended September 30, 2005, $131,000 and $218,000 of interest expense wasrecorded, respectively.

 

**7.****              Long-termObligations**

 

The carrying valueof long-term obligations is as follows:

 
| ** **                  | ** ** | **As of:**              | ** ** |
|-----------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| Capital lease obligations   |       | $                       | 67,911     |   | $ | 205,419 |   |
| Notes payable               |       | 13,273,496              |       | 3,368,787 |   |
| Other long-term obligations |       | 5,436,286               |       | — |   |
|                        |       | 18,777,693              |       | 3,574,206 |   |
| Less current maturities     |       | (5,884,373              | )          | (1,071,627 | ) |
| Long-term obligations, net  |       | $                       | 12,893,320 |   | $ | 2,502,579 |   |

 

Long-termobligations, including current maturities, outstanding as of September 30, 2005consisted of capital equipment leased under various capital lease arrangements,promissory notes under an equipment financing line (described below), borrowingsunder a facility loan agreement and amounts due under a patent transferagreement.  Monthly payments under thecapital lease obligations mature through June 2010.

 

In June 2005, theCompany entered into a $7.0 million equipment financing line with OxfordFinance Corporation. Borrowings under this equipment line can be made againstqualified purchases, subject to review and approval by Oxford FinanceCorporation, through April 2006. Such borrowings are to be collateralized bycorresponding qualified purchases and repaid over 36 to 48 months,depending on the nature of the equipment financed. No warrants were granted inconnection with this equipment line. The $7.0 million equipment line isstructured as a loan agreement. Interest rates are fixed at the time of eachborrowing under the equipment line with such rates adjusted between borrowingsbased on the U.S. Federal Reserve’s Three Year and Four Year Treasury ConstantMaturity Rates. Interest rates on borrowings made through September 30, 2005 onthis line range from 10.3% to 10.4%, respectively. The loans under thisfinancing line are subject to acceleration upon the happening of certaincustomary events of default, including failure to timely pay principal andinterest. As of September 30, 2005, the Company had cumulatively borrowed $2.4million under this line, of which $2.3 million was outstanding net ofrepayments. Monthly payments for the amounts outstanding under the equipmentfinancing line mature through August 2009.

 

InApril 2004, the Company entered into an equipment financing line with GeneralElectric Capital Corporation. In 2004 and 2005, the Company borrowed anaggregate of $10.5 million against this line. As of September 30, 2005, net ofrepayments, the Company had $9.0 million outstanding under this line. Suchborrowings are collateralized by corresponding equipment and other capitalpurchases with repayment due in monthly installments over 36 to 48 months,depending on the nature of the equipment financed, with the last such repaymentscheduled for March 2009. Interest rates on these borrowings were fixed at thetime of each borrowing and range from 8.9% to 10.1%. No further additional amountmay be borrowed under this line. The loans under this line are subject toacceleration upon the happening of certain customary events of default,including failure to timely pay principal and interest.

 

InAugust 2004, the Company entered into a loan agreement withMassDevelopment under which up to $2.0 million of financing is available uponcompletion by the Company of certain tenant improvements to its commercialmanufacturing facility in Tewksbury, Massachusetts.  In March 2005, the Company borrowed $2.0million under this loan agreement. Interest accrues under the loan at 5.0% per annum with retroactiveadjustments to 9% upon reaching certain defined earning levels. The repaymentof principal and accrued interest will coincide with the term of the Tewksburylease which has a five-year, nine-month term with options to extend the leasefor up to two additional five-year terms. No payments are due under the loanuntil April 2007. Unpaid interest during this 

 

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twenty-four monthperiod shall be accrued and principal and interest shall be repaid on a monthlybasis thereafter such that the total amount outstanding shall fully amortizeover the balance of the term in equal installments. The loan is subject toacceleration upon certain customary events of default, including failure totimely pay principal and interest. The loan is secured by certain of the tenantimprovements made at the Tewksbury facility.

 

The retroactiveinterest rate adjustment feature of the MassDevelopment loan agreement is deemedto be an embedded derivative instrument requiring separate accounting under “FASB133”, Accounting for Derivative Instruments and Hedging Activities, and wasinitially valued at $62,000. The derivative asset is amortized as interestexpense over a term beginning with the loan agreement effective date and endingwith the currently expected payment date of the retroactive interest.  The fair value of the derivative liabilitywill be re-measured at each reporting period, with any change in value chargedor credited to interest expense.  Therewas no change in the estimated fair value of the derivative liability duringthe three and nine month periods ending September 30, 2005.

 

On May 11, 2005,Acusphere entered into a patent transfer agreement with Schering.  See Note 6. In consideration of the agreement, the Company agreed to pay Schering atotal of $7.0 million of which $1.0 million was paid in May 2005, $3.0 million isdue in May 2006, and $3.0 million is due in May 2007. Because the Company hasnot demonstrated technological feasibility or an alternative future use forthese patents, the present value of this acquisition cost, $6.2 million, wasexpensed at the time of acquisition, with the remaining payments recorded asliabilities on our consolidated balance sheet, of which  $2.8 million are classified as currentliabilities and $2.6 million are classified as long-term liabilities.

 

**8.****              Deferred Revenue**

 

In July 2004, theCompany entered into a collaboration, license and supply agreement with Nycomedin which the Company granted Nycomed rights to develop and market AI-700 inEurope. As part of this agreement, as of September 30, 2005, Nycomed has paidthe Company $4.0 million in license fees and the first five of eightconsecutive quarterly installments of $1.0 million each for the Company’sresearch and development efforts. As of September 30, 2005, the Company hascumulatively recognized $4.3 million in revenue, reflecting an estimated periodof forty-two months over which the $12 million in scheduled payments areexpected to be earned, and $4.7 million of such payments were reported by theCompany as deferred revenue.

 

During the three and ninemonths ended September 30, 2005, in connection with this agreement, the Companypaid fees of $45,000 and $240,000, respectively, to an advisor retained inconnection with the Nycomed collaboration agreement. Additional fees payable tothis advisor are dependent upon the timing and magnitude of the amounts paid byNycomed to the Company.  The maximum cashamount payable to this advisor in connection with the Nycomed collaborationagreement is approximately $1.1 million of which $565,000 has been paid throughSeptember 30, 2005.

 

**9.****              Stockholders’Equity**

 

OnSeptember 28, 2005, the Company sold 3,566,000 shares of its common stockat $5.25 per share resulting in aggregate gross proceeds to the Company of$18.7 million (net proceeds of approximately $17.5 million after deductingunderwriting discounts and commissions and estimated offering expenses). Inconnection with the offering, the Company agreed for a period of 90 daysfollowing the offering of common stock to refrain from directly or indirectlyselling or offering to sell any shares of common stock or securitiesconvertible into or exchangeable or exercisable for shares of common stock, orfiling a registration statement relating to the offer of its common stock orsecurities convertible into or exchangeable or exercisable for shares of commonstock.

 

On February 24,2005, the Company issued 900,000 shares of 6.5% convertible exchangeable preferredstock (the “Preferred Stock”) at $50.00 per share resulting in aggregate grossproceeds to the Company of $45.0 million (net proceeds of approximately $41.9million after deducting underwriting discounts and commissions and estimatedoffering expenses).  Each share ofPreferred Stock has a liquidation preference of $50.00 per share.  Dividends on the Preferred Stock are cumulativefrom the date of original issue at the annual rate of $3.25 per share, payablequarterly on the first day of March, June, September, and December.  Any dividends must be declared by the Company’sboard of directors and must come from funds that are legally available fordividend payments.  On September 1, 2005,a quarterly dividend payment on shares of Preferred Stock in the aggregate amountof $731,000 was paid to the holders of record as of the close of business on August15, 2005. During the nine months ended September 30, 2005, dividends earned onthe Preferred Stock totalled $1.8 million, of which $1.5 million was paid as ofSeptember 30, 2005.

 

In November 2005,the Company’s board of directors declared a quarterly dividend in the amount of$0.8125 per share of 

 

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Preferred Stock, which isscheduled to be  paid on December 1,2005, to the holders of record as of the close of business on November 15,2005.

 

The PreferredStock is convertible into the Company’s common stock at any time at the optionof the holder at a conversion rate of 7.2886 shares of common stock for eachshare of Preferred Stock, based on an initial conversion price of $6.86 pershare.  The initial conversion price issubject to adjustment in certain customary events, but is not subject to “pricebased” anti-dilution adjustment. The Company has reserved approximately 6.6million shares of common stock for issuance upon such conversion.

 

The Company mayelect to automatically convert some or all of the Preferred Stock into sharesof common stock if the closing price of the Company’s common stock has exceeded$10.30 per share (150% of the conversion price) for at least 20 trading days duringany 30-day trading period, ending within five trading days prior to notice ofautomatic conversion.  Prior to March 1,2009, if the Company elects to automatically convert, or if any holder electsto voluntarily convert, the Preferred Stock, the Company will also make anadditional payment (“Make-Whole” payment) equal to the aggregate amount ofdividends that would have been payable on the Preferred Stock so converted fromthe original date of issuance through and including March 1, 2009, less anydividends already paid on the Preferred Stock. This additional payment is payable by the Company, at its option, incash, in additional shares of its common stock, or in a combination of cash andshares of common stock.  The Company has reserveda maximum of approximately 2.0 million shares of common stock for issuanceunder this Make-Whole provision.

 

As of September30, 2005, no holders had voluntarily converted shares of Preferred Stock. In October2005, 40,000 shares of Preferred Stock were voluntarily converted into 291,545shares of the Company’s common stock.  Inconnection with such conversions, the Company issued an additional 76,214shares of the Company’s common stock in satisfaction of the required Make-Wholepayment.

 

In accordance withSFAS 133, the Company is required to separate and account for as an embeddedderivative, the dividend make-whole payment feature of the Preferred Stockoffering. As an embedded derivative instrument, the dividend make-whole paymentfeature must be measured at fair value and reflected as a liability. Changes inthe fair value of the derivative are recognized in earnings as a component ofOther Income (Expense). The Company determined the fair value of the dividendmake-whole payment feature to be $3.0 million at February 24, 2005 (thecommitment date). This amount was allocated from the proceeds of the PreferredStock to the derivative liability. As of September 30, 2005, the derivative liabilitywas valued at $1.6 million resulting in the incurrence of $20,000 of otherexpense and the recognition of $1.4 million of other income during the threeand nine months ended September 30, 2005, respectfully.

 

The Company may elect toredeem the Preferred Stock at declining redemption prices on or after March 6,2009.

 

The Preferred Stock isexchangeable, in whole but not in part, at the option of the Company on anydividend payment date beginning on March 1, 2006 (the “Exchange Date”) for theCompany’s  6.5% convertible subordinateddebentures (“Debentures”) at the rate of $50 principal amount of Debentures foreach share of Preferred Stock.  TheDebentures, if issued, will mature 25 years after the Exchange Date and haveterms substantially similar to those of the Preferred Stock.

 

The Preferred Stock hasno maturity date and no voting rights prior to conversion into common stock,except under limited circumstances.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS****OF OPERATIONS**

 

**Forward Looking Statements MayProve Inaccurate**

 

*Statementsmade in this Form 10-Q, including without limitation, “Management’s Discussionand Analysis of Financial Condition and Results of Operation,” contain certainprojections, estimates and other forward-looking statements. “Forward-lookingstatements,” as that term is defined in the Private Securities LitigationReform Act of 1995, are not historical facts and involve a number of risks and uncertainties.Words herein such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,”“anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,” “potential,”and similar expressions (as well as other words or expressions referencingfuture events, conditions or circumstances) are intended to identifyforward-looking statements.*

 

*Forward-lookingstatements include, but are not limited to: our plans to develop and market newproducts and the timing of these development programs, in particular the timing,size and enrollment of clinical trials and timing of regulatory milestones forAI-700; our clinical development of product candidates, clinical trials and ourability to obtain and maintain regulatory approval for our product candidates;our estimates regarding our capital requirements and our needs for additionalfinancing; our estimates of future expenditures for and the timing of ourbuild-out and qualification of our commercial manufacturing facility inTewksbury, Massachusetts; our estimates of expenses and future revenues andprofitability; our estimates of the size of the potential markets for ourproduct candidates; our selection and licensing of product candidates; ourability to attract collaborators with acceptable development, regulatory andcommercialization expertise; the benefits to be derived from corporatecollaborations, license agreements and other collaborative efforts, includingthose relating to the development and commercialization of our productcandidates; sources of revenues and anticipated revenues, includingcontributions from corporate collaborations, license agreements and othercollaborative efforts for the development and commercialization of products;our ability to create an effective direct sales and marketing infrastructurefor products we elect to market and sell directly; the rate and degree ofmarket acceptance of our product candidates; the timing and amount ofreimbursement for our product candidates; the success of other competingtherapies that may become available; and the manufacturing capacity for ourproduct candidates, including our commercial manufacturing facility for AI-700.*

 

*Ouractual results and the timing of certain events may differ materially from theresults discussed, projected, anticipated or indicated in any forward-lookingstatements. Any forward-looking statement should be considered in light offactors discussed in  “Certain FactorsWhich May Affect Future Results” and elsewhere in this report. We cautionreaders not to place undue reliance on any such forward-looking statements,which speak only as of the date they are made. We disclaim any obligation,except as specifically required by law and the rules of the Securities andExchange Commission, to publicly update or revise any such statements toreflect any change in company expectations or in events, conditions orcircumstances on which any such statements may be based, or that may affect thelikelihood that actual results will differ from those set forth in theforward-looking statements.*

 

*Thefollowing discussion should be read in conjunction with our consolidatedfinancial statements and related notes thereto included elsewhere in thisForm 10-Q.*

 

**Overview**

 

We are a specialtypharmaceutical company that develops new drugs and improved formulations ofexisting drugs using our proprietary porous microparticle technology. We arefocused on developing proprietary drugs that can offer significant benefitssuch as improved safety and efficacy, increased patient compliance, greaterease of use, expanded indications or reduced cost. Our three initial productcandidates are designed to address large unmet clinical needs withincardiology, oncology and asthma. Our lead product candidate is a cardiovasculardrug in Phase 3 clinical development for the detection of coronary heartdisease, the leading cause of death in the United States.

 

We created ourinitial product candidates using technology that enables us to control the sizeand porosity of particles in a versatile manner, so we can customize theparticles to address the delivery needs of a variety of drugs. We are focusedon creating porous microparticles that are smaller than red blood cells. Someof these microparticles are nanoparticles which are smaller than 1 micron.Small microparticles are important for delivering drugs intravenously so thatthey can pass through the body’s smallest blood vessels, for increasing thesurface area of a drug so that the drug will dissolve more rapidly, and fordelivering drugs to the lung via inhalation. Porosity is important forentrapping gases in microparticles, for controlling the release rate of thedrug from a microparticle, and for targeting inhaled drugs to specific regionsof the lung.

 

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We have incurredsignificant operating losses to develop our product candidates and weanticipate continuing to incur significant operating losses in the comingyears. In particular, we expect to incur significant additional expenses andexperience other significant capital requirements for the conduct of our Phase3 clinical program for AI-700 and to complete the build-out and qualificationof a manufacturing facility for the initial commercial manufacture of AI-700.Since our inception, we have funded our operations primarily through privateand public placements of equity securities, equipment-backed financings andother debt financings.

 

**AI-700Phase 3 Clinical Trial Update**

 

The Phase 3clinical plan provides for a two-part program consisting of a pilot phase (the “pilotstudy”), under which new investigators and blinded readers have been qualifiedand trained, and two multi-center pivotal trials (the “32” and “33” trials), inwhich we currently plan to enroll approximately 700 patients with known or suspectedcoronary heart disease. The Phase 3 pivotal trials include clinical siteslocated in North America, Europe and Australia with data from the trialsintended for submission to U.S., European and potentially other regulatoryauthorities. As of the date of this report, over 600 patients have beenenrolled in the Phase 3 pivotal trials and over 700 patients have been enrolledin the Phase 3 program, including the pivotal trials and the pilot study. Wecurrently anticipate completing cumulative enrollment of at least 700 patientsin the pivotal trials in early 2006. Currently we plan to file a NDA for AI-700in 2006.

 

*ThePilot Study.*    Our objectives in thepilot study were to train and qualify a sufficient number of clinical sites,investigators and blinded readers for transition into one of the two pivotaltrials. These objectives have been accomplished and enrollment in this trial iscompleted. Clinical sites trained in the pilot study transitioned into apivotal trial when, in our judgment, the clinical site demonstrated that it wasprepared to meet the requirements of the clinical trial protocol. Because thepilot study was conducted for training purposes, there are no defined clinicalefficacy endpoints for this study.

 

*ThePivotal Trials.*    More than twentyclinical sites are participating in the two pivotal trials, and both trials areactive in enrolling patients. As part of the Phase 3 pivotal study design, theevaluation of AI-700 enhanced stress echo and nuclear stress images from thepivotal trials is performed by blinded readers who receive no information aboutthe patient being evaluated other than the images. Safety continues to betested and evaluated during our pivotal trials.

 

*The“32” Trial.*    All of the patientsenrolled in this trial will receive a stress echo study with AI-700 and anuclear stress test. Patients in this pivotal trial will generally undergocoronary angiography only if they have a positive nuclear stress test result.Patients in this pivotal trial who have a negative nuclear stress test resultwill be evaluated for ninety days thereafter for cardiac events. The primaryendpoints for this pivotal trial are sensitivity and specificity, relative to atruth standard, in comparison to nuclear stress testing, with angiography or coronaryartery disease status with nuclear stress if angiographic data are unavailableas the truth standard for both modalities.

 

*The“33” Trial.*    All of the patientsenrolled in this trial will receive a stress echo study with AI-700 and willundergo coronary angiography. The majority of patients, but not all, will havea nuclear stress test. All patients in this trial will be followed up for up tothirty days following the stress echo study. The primary endpoints for this pivotal trial are sensitivity andspecificity, relative to a truth standard, in comparison to nuclear stress testing, with angiography as the truthstandard for both modalities.

 

*TrialDesign and Purpose.*  Webelieve that stress echo with AI-700 has the potential to significantly reducethe time, cost and resources needed in the assessment of myocardial perfusion,compared to nuclear stress testing. Myocardial perfusion is blood flow to theheart muscle, a sensitive marker for coronary heart disease.  There is no ultrasound contrast agentapproved by FDA for use in stress echo or myocardial perfusion imaging. Basedupon the end points described above, our 32 and 33 trials are designed todemonstrate non-inferiority of stress echo with AI-700 to nuclear stresstesting.

 

In addition toenrolling patients in the Phase 3 trials, blinded reads are being performed onthe images generated in these studies and data is collected from these blindedreads. A blinded read is an evaluation of the data from the nuclear stresstests and from the stress echo tests with AI-700 by clinicians who have accessonly to the data from these tests and do not have direct contact with thestudied patients or knowledge of the studied patients’ medical history.  We have completed blinded reads on more thanhalf the currently enrolled patients in each of the 32 and 33 trials.

 

After completionof the blinded reads and collection of all the data, we plan to conductadditional quality control checks before “locking” the database. Once thedatabase is locked, it will be unblinded and available to us for analysis andprepared for public release.  Because ofthe ninety day follow-up period required under the 32 trial protocol forpatients who have a negative nuclear stress test, we expect that the data fromthe 33 trial may be available to us prior to the data from the 32 trial.  We plan to release the 

 

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results of each trialshortly after they become available rather than waiting for the results of bothtrials.  Based on our current plans, weintend to announce summary results of the outcomes of the trials withinapproximately three months of each study’s completion.

 

InApril 2005, based in part upon feedback from FDA, we revised thestatistical analysis plan on which we base our patient enrollment estimates forthe AI-700 Phase 3 clinical trials. Since that time we have continueddiscussions with the FDA.  Although wecontinue to believe our estimates are reliable, these discussions could lead toadditional changes relating to the Phase 3 clinical trials, including thestatistical analysis plans. The above described estimates of clinicalendpoints, patient enrollment requirements and timing reflect our currentassumptions based upon FDA feedback, our knowledge and experience and theguidance of our advisors.  Although weare targeting these clinical endpoints, enrollment requirements and timing forclinical enrollment, blinded reads, data lock, data release and NDA filing inour Phase 3 trials, we cannot assure you that these timelines will be met,nor can we assure you that we will successfully achieve results that meet orexceed the clinical endpoint of these Phase 3 trials.

 

**AI-700Manufacturing Facility Update**

 

In July 2004,we entered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts.  InSeptember 2004, we began to build-out the manufacturing space portion ofthis facility to meet the initial commercial manufacturing requirements of AI-700. We intend to demonstrate that we can produce AI-700 at a commercialmanufacturing scale prior to our filing of a NDA for AI-700 and, subject torequired regulatory approvals, we intend to manufacture AI-700 in this facilityfor commercial use. This commercial manufacturing facility must comply withcurrent good manufacturing practices, or cGMPs, required by the FDA, and similarmanufacturing requirements required by foreign regulatory agencies.

 

In October 2005 wereceived an occupancy permit for this commercial manufacturing facility. Thebuild-out of the facility is substantially complete, with minor items remainingto be addressed by the contractor.  Asidefrom addressing minor items, our primary efforts at this facility are currentlydirected at starting-up and qualifying equipment and operations in compliancewith cGMP’s. We plan to complete this start-up and qualification phase in 2006.

 

We have enteredinto an engineering and construction management services agreement with a contractorcovering the provision of engineering, design and construction managementservices through completion of the build-out of the facility.  The totalvalue of this cost-plus percentage fee type contract is $25.8 million of which$22.2 million was paid on or before September 30, 2005. The build-out of thefacility is substantially complete, with minor items remaining to be addressedby the contractor. We expect that our total payments for substantiallycompleting the remaining items, excluding equipment purchases, will beapproximately $4.1 million in excess of the amounts that we already paidthrough September 30, 2005, or approximately $500,000 in excess of the currentcontract value.

 

These historicaland prospective capital amounts exclude the cost of our manufacturingequipment.  We have entered into an agency procurement agreement with acontractor covering the purchase of equipment in connection with the build-outof the Tewksbury facility.  As of November 9, 2005, the total estimatedvalue of equipment to be purchased under this agreement was $4.3 million, ofwhich $3.9 million was paid for as of September 30, 2005.

 

Although thebuild-out of the facility is substantially complete, we cannot assure you thatwe will not incur costs in excess of the current estimated amounts to completethis build-out or that we will not encounter complications in the start-up andqualification of operations in this facility.

 

In March 2005 weborrowed $2.0 million under a loan agreement with the Massachusetts DevelopmentFinance Agency, the economic development authority of the Commonwealth ofMassachusetts, to help fund build-out costs related to the Tewksbury facility.

 

**Financial Operations Overview**

 

*Revenue.*    Wehave not generated any revenue from product sales since our inception. Inconnection with our collaboration agreement with Nycomed, as of September 30,2005 we have received $9.0 million in license fees and research anddevelopment payments and we anticipate receiving an additional $3.0 million insuch research and development payments in quarterly installments of $1.0million through June 2006. Further in the future, we will seek to generaterevenue from a combination of product sales, up-front or milestone payments andmanufacturing payments in connection with collaborative or strategicrelationships, and royalties resulting from the license of our products andintellectual property.

 

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*Researchand Development Expense.*    Research anddevelopment expense consists of expenses incurred in developing, manufacturingand testing product candidates. These expenses consist primarily of salariesand related expenses for personnel, fees paid to professional service providersin conjunction with independently monitoring our clinical trials and acquiringand evaluating data in conjunction with our clinical trials, costs of contractmanufacturing services, costs of materials used in clinical trials and researchand development, costs incurred to validate manufacturing equipment andfacilities, depreciation of capital resources used to develop our products,costs of facilities, the legal costs of pursuing patent protection on selectelements of our intellectual property and stock-based compensation. We expenseresearch and development costs, including patent related costs, as incurred. Webelieve that significant investment in product development is a competitivenecessity and plan to continue these investments in order to realize thepotential of our product candidates and proprietary technologies. Developmentprograms for later stage product candidates, such as AI-700, tend to cost morethan earlier stage programs due to the length and the number of patientsenrolled in clinical trials for later stage programs and due to costs ofscaling production to commercial scale.

 

*Generaland Administrative Expense.*    Generaland administrative expense consists primarily of salaries and other relatedcosts for personnel in executive, finance, accounting, information technology,business development and human resource functions. Other costs include facilitycosts not otherwise included in research and development expense, professionalfees for legal and accounting services and stock-based compensation.

 

*InterestIncome.*    Interest income consists ofinterest earned on our cash and cash equivalents.

 

*InterestExpense.*    Interest expense consists ofinterest incurred on equipment leases and other financing arrangements.  Interest expense also includes interestrecognized in connection with embedded derivatives.

 

*Changein Valuation of Derivative.*    Change invaluation of derivative consists of other income (expense) recognized orincurred on the change in estimated fair value of derivatives at the end ofeach reporting period.

 

*Stock-BasedCompensation Expense.*    Included withinresearch and development expenses and general and administrative expenses isstock-based compensation expense. Stock-based compensation expense, which is anon-cash charge, results principally from stock option grants to our employeesat exercise prices deemed for accounting purposes to be below the fair marketvalue of our stock on the date the stock options were granted (“fixed awards”).Prior to our initial public offering, which closed on October 14, 2003, wegranted certain stock options for which the exercise prices were deemed foraccounting purposes to be below the fair value of the underlying common stockresulting in our recording stock-based compensation expense associated withsuch grants. Stock-based compensation expense is also recorded for stock optiongrants to non-employees and for restricted stock grants provided to directorsand advisors in lieu of cash compensation. Deferred compensation (foraccounting purposes) on fixed awards is amortized as a charge to operationsover the vesting periods of the options and grants, subject to adjustment forforfeiture during the vesting period.

 

**Results of Operations**

 

*Three Months Ended September 30, 2005 and 2004*

 

*Revenue.*    Collaborationrevenue was $0.9 million in the three months ended September 30, 2005 and September30, 2004. Collaboration revenue is earned under our agreement with Nycomedwhich was entered into in July 2004. Under this agreement, excluding anypayments that we might receive based upon the achievement of specified milestones,we are scheduled to receive $12 million in license fees and research anddevelopment payments through June 2006, of which $9.0 million wasreceived through September 30, 2005. We recognize revenue associated with thesepayments ratably over a period of forty-two months, representing the estimateddevelopment period over which such fees are earned.

 

*Researchand Development Expense.*    Research anddevelopment expense increased $3.1 million, or 53.1%, to $8.9 million in thethree months ended September 30, 2005 from $5.8 million in the three monthsended September 30, 2004.  The increasein research and development expense is primarily due to a $2.2 million increasein direct costs, due to a $0.6 million increase in salary, a $0.6 million increasein consulting and contract services and a $0.6 million increase in materialsand supplies. These increases are primarily due to activities relating toAI-700, including increased Phase 3 clinical program costs and increased costsassociated with preparing for commercial manufacturing of AI-700.

 

The followingtable summarizes the primary components of our research and development expensefor the three months ended September 30, 2005 and 2004:

 

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| ** **                              | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                              | ** ** | **(in thousands)**      | ** ** |
| Total direct costs                      |       | $                       | 6,577      |   | $ | 4,363 |   |
|                                    |       |                    |       |   |   |
| Indirect costs:                         |       |                    |       |   |   |
| Facility costs                          |       | 1,103                   |       | 788 |   |
| Depreciation                            |       | 646                     |       | 282 |   |
| Stock-based compensation                |       | 49                      |       | 88 |   |
| All other indirect costs                |       | 481                     |       | 264 |   |
| Total indirect costs                    |       | 2,279                   |       | 1,422 |   |
|                                    |       |                    |       |   |   |
| Total research  and development expense |       | $                       | 8,856      |   | $ | 5,785 |   |

 

*LateStage Clinical Development Program*.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our late stage clinical development program relates to ourlead product candidate, AI-700, which is a cardiovascular drug for thedetection of coronary heart disease. Almost all of our direct research anddevelopment expenditures for the three months ended September 30, 2005 and 2004related to our AI-700 program. As discussed in the preceding paragraph, theincrease in direct research and development costs in the three months ended September30, 2005 compared to the same period in 2004 reflects increased Phase 3clinical program costs and increased costs associated with preparing forcommercial manufacturing of A1-700. The increased costs reflects a highernumber of clinical sites enrolling patients in the AI-700 Phase 3 clinicalprogram, a higher rate of patient enrollment in these clinical trials andrelated increases in costs for clinical data management and independentclinical site monitoring. Patient enrollment and related costs are anticipated tovary from quarter to quarter but are generally anticipated to be higher in 2005than in 2004.  The increase in researchand development costs also includes costs associated with increasing full andpart-time personnel.

 

In July 2004,we entered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts.  In September 2004, we began to build-out themanufacturing space of this facility for commercial manufacturing of AI-700. Weintend to demonstrate that we can produce AI-700 at a commercial manufacturingscale prior to our filing of a NDA for AI-700 and, subject to requiredregulatory approvals, we intend to manufacture AI-700 in this facility forcommercial use.  The increase in researchand development costs in the three months ended September 30, 2005 compared tothe same period in 2004 reflects operating costs associated with our Tewksbury,Massachusetts facility, including costs associated with validating thefacility, and increased depreciation expense due to capital  purchases primarily relating to ourmanufacturing operations.  We anticipateincurring increased costs associated with validation of this facility and itsequipment and processes the purchase of raw materials and laboratory supplies, theincreased use of consultants, and the hiring of additional personnel.

 

*EarlyStage Clinical Development Programs*.  Our initial clinical applications of ourHydrophobic Drug Delivery System (“HDDS”), AI-850, and our Pulmonary DrugDelivery System (“PDDS”) technology, AI-128, have completed a Phase 1 trial.During 2005, our plan is to spend less than $1 million on HDDS and PDDSproduct development unless we enter into an agreement with a strategiccollaborator to help us fund HDDS or PDDS related product development whichsignificantly changes our plans.

 

Each of ourresearch and development programs is subject to risks and uncertainties,including the requirement to seek regulatory approvals, which are outside ofour control. For example, our AI-700 clinical trials may be subject to delaysor rejections based on changes in the size of the trials to meet statisticalrequirements, our inability to enroll patients at the rate and in theproportion of patients with and without disease that we expect or our inabilityto produce clinical trial material in sufficient quantities and of sufficientquality to meet the schedule for our planned clinical trials. Moreover, theproduct candidates identified in these research and development programs,particularly our early stage programs, must overcome significant technological,manufacturing and marketing challenges before they can be successfullycommercialized. As a result of these risks and uncertainties, we are unable topredict with any certainty the period in which material net cash inflows fromsuch projects could be expected to commence or the completion date of theseprograms. Failure to commercialize these product candidates on a timely basiscould have a material adverse affect on our business, financial condition andresults of operations. We may seek to establish collaborative relationships tohelp us commercialize these product candidates, but there can be no assurancethat we will be successful in doing so.

 

*Generaland Administrative Expense.*    General andadministrative expense increased $0.2 million, or 15.5%, to $1.7 million forthe three months ended September 30, 2005 from $1.5 million in the three monthsended September 30, 2004.  The increasein general and administrative expense was principally due to additionalpersonnel and consultants.

 

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We anticipate someoverall increase in general and administrative expense during the balance of2005, including increases in costs for investor relations, business developmentand other activities. Certain of our general and administrative costs, such ascost associated with business development activities, may vary significantlybetween periods.

 

*InterestIncome.*    Interest income increased $0.3million, or 208.7%, to $0.5 million in the three months ended September 30,2005 from $0.1 million in the three months ended September 30, 2004.  Theincrease in interest income was primarily due to higher average fund balancesavailable for investment resulting from the $45.0 million Preferred Stockfinancing in February 2005.

 

*InterestExpense.*    Interest expense increased to$0.4 million in the three months ended September 30, 2005 from $26,000 in thethree months ended September 30, 2004.  The increase in interest expense was primarily related to cumulative borrowingsof approximately $18.7 million through September 30, 2005 under our two equipmentfinancing lines and non-cash interest charges of $131,000 related to theSchering patent agreement.

 

*Changein Valuation of Derivative.*    Change invaluation of derivative increased $20,000 for the three months ended September30, 2005 from zero in the three months ended September 30, 2004. The change inthe derivative liability is related to the embedded derivative instrument fromthe dividend make-whole payment feature of the Preferred Stock offering thatclosed in February 2005.

 

*Effect ofPreferred Stock on Loss Available to Common Stockholders*. Dividendson preferred stock increased to $0.7 million in the three months endedSeptember 30, 2005 from zero in the three months ended September 30, 2004.  The increase in dividends on Preferred Stockwas related to the quarterly dividend earned during the three months endedSeptember 30, 2005.

 

*Nine Months Ended September 30, 2005 and 2004*

 

*Revenue.*    Collaborationrevenue was $2.6 million in the nine months ended September 30, 2005compared to $0.9 million for the nine months ended September 30, 2004.Collaboration revenue is earned under our agreement with Nycomed which was enteredinto in July 2004. Under this agreement, excluding any payments that wemight receive based upon the achievement of specified milestones, we arescheduled to receive $12 million in license fees and research anddevelopment payments through June 2006, of which $9.0 million wasreceived through September 30, 2005. We recognize revenue associated with thesepayments ratably over a period of forty-two months, representing the estimateddevelopment period over which such fees are earned.

 

*Researchand Development Expense.*    Research anddevelopment expense increased $14.2 million, or 80.7%, to $31.8 million in thenine months ended September 30, 2005 from $17.6 million in the nine monthsended September 30, 2004.  The largestportion of the increase in research and development expense resulted from our $7million patent transfer agreement with Schering.  During the nine months ended September 30,2005, we expensed $6.2 million, the estimated present value of this acquisitioncost at the time of the agreement, with the remaining $0.8 million of thisobligation being amortized as non-cash interest expense over the term of thescheduled payments to Schering. The increase in research and developmentexpense is primarily due to a $6.1 million increase in direct costs, due to a$1.3 million increase in salary, a $1.9 million increase in consulting andcontract services and a $1.9 million increase in materials and supplies. Theseincreases are primarily due to activities relating to AI-700, includingincreased Phase 3 clinical program costs and increased costs associated with preparingfor commercial manufacturing of AI-700.

 

The followingtable summarizes the primary components of our research and development expensefor the nine months ended September 30, 2005 and 2004:

 

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| ** **                              | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                              | ** ** | **(in thousands)**      | ** ** |
| Total direct costs                      |       | $                       | 19,508     |   | $ | 13,439 |   |
|                                    |       |                    |       |   |   |
| Indirect costs:                         |       |                    |       |   |   |
| Facility costs                          |       | 3,071                   |       | 2,319 |   |
| Depreciation                            |       | 1,779                   |       | 875 |   |
| Stock-based  compensation               |       | 164                     |       | 267 |   |
| Schering patent  transfer costs         |       | 6,218                   |       | — |   |
| All other indirect  costs               |       | 1,020                   |       | 680 |   |
| Total indirect costs                    |       | 12,252                  |       | 4,141 |   |
| Total research  and development expense |       | $                       | 31,760     |   | $ | 17,580 |   |

 

*LateStage Clinical Development Program*.  Research and development costs generallyincrease as programs progress from early stage clinical trials to late stageclinical trials. Our late stage clinical development program relates to ourlead product candidate, AI-700, which is a cardiovascular drug for thedetection of coronary heart disease. Almost all of our direct research anddevelopment expenditures for the nine months ended September 30, 2005 and 2004related to our AI-700 program. As discussed in the preceding paragraph, theincrease in direct research and development costs in the nine months endedSeptember 30, 2005 compared to the same period in 2004 reflects increased Phase3 clinical program costs and increased costs associated with preparing for commercialmanufacturing of A1-700. The increased costs reflects a higher number ofclinical sites enrolling patients in the AI-700 Phase 3 clinical program, ahigher rate of patient enrollment in these clinical trials and relatedincreases in costs for clinical data management and independent clinical sitemonitoring. Patient enrollment and related costs are anticipated to vary fromquarter to quarter but are higher in 2005 than in 2004.  The increase in research and developmentcosts also includes costs associated with increasing full and part-timepersonnel.

 

In July 2004,we entered into a lease agreement for 58,000 square feet of commercialmanufacturing and office space in Tewksbury, Massachusetts.  In September 2004, we began to build-out themanufacturing space of this facility for commercial manufacturing of AI-700. Weintend to demonstrate that we can produce AI-700 at a commercial manufacturingscale prior to our filing of a NDA for AI-700 and, subject to requiredregulatory approvals, we intend to manufacture AI-700 in this facility forcommercial use.  The increase in researchand development costs in the nine months ended September 30, 2005 compared tothe same period in 2004 reflects operating costs associated with our Tewksbury,Massachusetts facility, including costs associated with validating thisfacility and its equipment and processes and increased depreciation expense dueto capital  purchases primarily relatingto our manufacturing operations. We anticipate incurring increased costsassociated with validation of this facility, the purchase of raw materials andlaboratory supplies, the increased use of consultants, and the hiring ofadditional personnel.

 

*EarlyStage Clinical Development Programs*.  Our initial clinical applications of our HDDStechnology, AI-850, and our PDDS technology, AI-128, have completed a Phase 1trial. During 2005, our plan is to spend less than $1 million on HDDS andPDDS product development unless we enter into an agreement with a strategiccollaborator to help us fund HDDS or PDDS related product development whichsignificantly changes our plans.

 

Each of ourresearch and development programs is subject to risks and uncertainties,including the requirement to seek regulatory approvals, which are outside ofour control. For example, our clinical trials may be subject to delays orrejections based on changes in the size of the trials to meet statisticalrequirements, our inability to enroll patients at the rate and in theproportion of patients with and without disease that we expect or our inabilityto produce clinical trial material in sufficient quantities and of sufficientquality to meet the schedule for our planned clinical trials. Moreover, theproduct candidates identified in these research and development programs,particularly our early stage programs, must overcome significant technological,manufacturing and marketing challenges before they can be successfullycommercialized. As a result of these risks and uncertainties, we are unable topredict with any certainty the period in which material net cash inflows fromsuch projects could be expected to commence or the completion date of theseprograms. Failure to commercialize these product candidates on a timely basiscould have a material adverse affect on our business, financial condition andresults of operations. We may seek to establish collaborative relationships tohelp us commercialize these product candidates, but there can be no assurancethat we will be successful in doing so.

 

*Generaland Administrative Expense.*    Generaland administrative expense increased $1.1 million, or 25.7%, to $5.6 millionfor the nine months ended September 30, 2005 from $4.4 million in the ninemonths ended September 30, 2004.  Theincrease in general and administrative expense was principally due toadditional personnel and consultants.

 

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We anticipate someoverall increase in general and administrative expense during the balance of2005, including increases in costs for investor relations, business developmentand other activities. Certain of our general and administrative costs, such ascost associated with business development activities may vary significantlybetween periods.

 

*InterestIncome.*    Interest income increased $0.9million, or 268.4%, to $1.3 million in the nine months ended September 30, 2005from $0.4 million in the nine months ended September 30, 2004.  Theincrease in interest income was primarily due to higher average fund balancesavailable for investment resulting from the $45.0 million Preferred Stockfinancing in February 2005.

 

*InterestExpense.*    Interest expense increased to$0.9 million in the nine months ended September 30, 2005 from $0.1 million inthe nine months ended September 30, 2004.  The increase in interest expense was primarily related to cumulativeborrowings of approximately $18.7 million through September 30, 2005 under ourtwo equipment financing lines and non-cash interest charges of $218,000 relatedto the Schering patent agreement.

 

*Changein Valuation of Derivative.*    Change invaluation of derivative increased to $1.4 million in the nine months ended September30, 2005 from zero in the nine months ended September 30, 2004. The increase inchange in valuation of derivative was related to the embedded derivativeinstrument from the dividend make-whole payment feature of the Preferred Stockoffering that closed in February 2005. We determined the fair value of thedividend make-whole payment feature to be $3.0 million at February 24, 2005 (thecommitment date). As of September 30, 2005, the derivative liability was valuedat $1.6 million resulting in the recognition of $1.4 million as other income for the nine month period ending September30, 2005.

 

*Effect ofPreferred Stock on Loss Available to Common Stockholders*.Dividends on Preferred Stock increased to $1.8 million in the nine months endedSeptember 30, 2005 from zero in the nine months ended September 30, 2004. Theincrease in dividends on Preferred Stock was related to the quarterly dividend earnedduring the nine month period ended September 30, 2005.  Our net loss available to common stockholdersincludes $0.2 million of dividends accumulated on preferred stock representingone month of dividend accumulated but not declared as of the end of the period.This amount of dividends accumulated is included in the calculation of pershare net loss available to common stockholders.

 

**Liquidityand Capital Resources**

 

Historically, wehave financed our business through the issuance of equity securities, debtfinancings, equipment leases and since the third quarter of 2004, a strategiccollaboration with Nycomed. Our liquidity requirements have arisen primarilyfrom research and development expenditures, equipment expenditures and paymentson outstanding indebtedness. As of September 30, 2005, we had cash and cashequivalents of $59.9 million. As of September 30, 2005 we owed $18.8 millionin notes payable and had commitments totaling $19.5 million for rent underour facility leases, including the lease agreement signed in July 2004 forcommercial manufacturing space in Tewksbury, Massachusetts.

 

During the ninemonths ended September 30, 2005, operating activities used $25.8 million ofcash. Net cash used by operating activities during this period resulted primarilyfrom a net loss of $33.0 million and a decrease in accounts payable of $2.2million. These uses of cash were partially offset by an increase in deferredrevenue of $3.0 million, a decrease in other current assets of $1.1million, non-cash charges for depreciation and amortization of $1.8 million,non-cash charges for the write-off of intellectual property acquisition costsof $5.2 million related to the Schering agreement and non-cash change invaluation of derivative of $1.4 million. Our operating spending will be higherin 2005 than in 2004 due to an estimated higher rate of patient enrollment inour Phase 3 clinical program and higher costs in connection with the validationof our manufacturing facility.  Weestimate such spending from operating activities will be approximately $8 to $10 millionper quarter through completion of enrollment in our AI-700 Phase 3 clinicaltrials in 2006**.**

 

During the ninemonths ended September 30, 2005, investing activities used $27.2 million incash. These uses of cash were primarily used for purchases of equipment andcosts incurred through September 30, 2005 for the build-out and expansion ofour manufacturing operations for AI-700 of $27.3 million.

 

During the ninemonths ended September 30, 2005, financing activities provided $67.8 millionin cash. Net cash provided by financing activities during this period resultedprimarily from net proceeds in connection with the sale of our convertibleexchangeable Preferred Stock of $41.9 million, a sale of common stock of$17.6 million, entering into promissory notes under the equipment financingline of $9.5 million, and borrowings of $2.0 million under a loanagreement with MassDevelopment. These proceeds were 

 

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partially offset bypayments on the capital leases and promissory notes of $1.7 million and paymentof Preferred Stock dividend of $1.5 million.

 

OnSeptember 28, 2005, the Company sold 3,566,000 shares of its common stockat $5.25 per share resulting in aggregate gross proceeds to the Company of$18.7 million (net proceeds of approximately $17.5 million after deductingunderwriting discounts and commissions and estimated offering expenses).

 

In June 2005, we enteredinto a $7.0 million equipment financing line with Oxford Finance Corporation.Borrowings under this equipment line can be made against qualified purchases,subject to review and approval by Oxford Finance Corporation, through April2006. Such borrowings are to be secured by qualified purchases and repaid over36 to 48 months, depending on the nature of the equipment financed. Nowarrants were granted in connection with this equipment line. The$7.0 million equipment line is structured as a loan agreement. Interestrates are fixed at the time of each borrowing under the equipment line withsuch rates adjusted between borrowings based on the U.S. Federal Reserve’sThree Year and Four Year Treasury Constant Maturity Rates. The loans under thisfinancing line are subject to acceleration upon the happening of certaincustomary events of default, including failure to timely pay principal andinterest. As of September 30, 2005, the Company had cumulatively borrowed $2.4million under this line, of which $2.3 million was outstanding net of repayments.Monthly payments for the amounts outstanding under the equipment financing linemature through August 2009. Monthly payments for the amounts outstandingunder the equipment financing line mature through August 2009.

 

In March2005, we borrowed $2.0 million under a loan agreement with MassDevelopment tohelp finance certain tenant improvements to our commercial manufacturingfacility in Tewksbury, Massachusetts.  Interestaccrues under the loan at 5.0% per annum with retroactive adjustments to 9%upon reaching certain defined earning levels. The repayment of principal andaccrued interest will coincide with the term of the Tewksbury lease which has afive-year, nine-month term with options to extend the lease for up to twoadditional five-year terms. No payments are due under the loan for the firsttwenty-four months. Unpaid interest during this twenty-four month period shallbe accrued and principal and interest shall be repaid on a monthly basisthereafter such that the total amount outstanding shall fully amortize over thebalance of the term in equal installments. The loan is subject to accelerationupon certain customary events of default, including failure to timely payprincipal and interest. The loan is secured by certain of the tenantimprovements made at the Tewksbury facility.

 

On February 24,2005, we issued 900,000 shares of 6.5% convertible exchangeable preferred stock,or Preferred Stock, at $50.00 per share resulting in aggregate gross proceedsto us of $45.0 million (net proceeds of approximately $41.9 million afterdeducting underwriting discounts and commissions and estimated offeringexpenses).  Each share of Preferred Stockhas a liquidation preference of $50.00 per share.  Dividends on the Preferred Stock will becumulative from the date of original issue at the annual rate of $3.25 pershare, payable quarterly on the first day of March, June, September, andDecember, commencing on June 1, 2005. Any dividends must be declared by our board of directors and must comefrom funds that are legally available for dividend payments.   During the nine months ended September 1,2005, we paid $1.5 million in dividends on shares of Preferred Stock.

 

The PreferredStock is convertible into shares of our common stock at any time at the optionof the holder at a conversion rate of 7.2886 shares of common stock for eachshare of Preferred Stock, based on an initial conversion price of $6.86 pershare.  The initial conversion price issubject to adjustment upon certain customary events, but is not subject to “pricebased” anti-dilution adjustment. We reserved approximately 6.6 million sharesof common stock for issuance upon conversion. As of September 30, 2005, no holders of the preferred stock hadconverted their shares.

 

We may elect toautomatically convert some or all of the Preferred Stock into shares of our commonstock if the closing price of our common stock has exceeded $10.30 per share(150% of the conversion price) for at least 20 trading days during any 30-daytrading period, ending within five trading days prior to notice of automaticconversion.  Prior to March 1, 2009, ifwe elect to automatically convert, or if any holder elects to voluntarily convert,the Preferred Stock, we will also make an additional payment, the Make-Wholepayment, equal to the aggregate amount of dividends that would have beenpayable on the Preferred Stock so converted from the original date of issuancethrough and including March 1, 2009, less any dividends already paid on thePreferred Stock.  This additional paymentis payable by us, at our option, in cash, in additional shares of its commonstock, or in a combination of cash and shares of common stock.   We have reserved a maximum of approximately 2.0million shares of common stock for issuance under this Make-Whole provision.

 

As of September30, 2005, no holders had voluntarily converted shares of Preferred Stock. InOctober 2005, 40,000 shares of Preferred Stock were voluntarily converted into291,545 shares of the Company’s common stock. In connection with such conversions, the Company issued an additional76,214 shares of the Company’s common stock in satisfaction of the requiredMake-

 

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Whole payment.

 

In accordance withStatement of Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments” (“SFAS 133”), we are required to separate and account, for, as anembedded derivative, the dividend make-whole payment feature of the PreferredStock offering. As an embedded derivative instrument, the dividend make-wholepayment feature must be measured at fair value and reflected as a liability.Changes in the fair value of the derivative are recognized in earnings as acomponent of Other Income (Expense). We determined the fair value of thedividend make-whole payment feature to be $3.0 million at February 24, 2005(the commitment date). This amount was allocated from the proceeds of thePreferred Stock to the derivative liability. At September 30, 2005, thederivative liability was valued at $1.6 million, resulting in the recognitionof $1.4 million as other income for the nine months ending September 30, 2005.

 

We may elect to redeemthe Preferred Stock at declining redemption prices on or after March 6, 2009.

 

The Preferred Stock isexchangeable, in whole but not in part, at our option on any dividend paymentdate beginning on March 1, 2006 (the “Exchange Date”) for our  6.5% convertible subordinated debentures (“Debentures”)at the rate of $50 principal amount of Debentures for each share of Preferred Stock.  The Debentures, if issued, will mature 25years after the Exchange Date and have terms substantially similar to those ofthe Preferred Stock.

 

The Preferred Stock hasno maturity date and no voting rights prior to conversion into common stock,except under limited circumstances.

 

We believe, basedon our operating plans, that our existing resources, including scheduledproceeds from Nycomed, will be adequate to fund our planned operations,including spending necessary to complete enrollment in our AI-700 Phase 3clinical program through 2006, or longer if we elect to reduce our rate ofspending.  Unless we reduce our current rateof spending, we will require significant additional funds, which we may raisethrough public or private sales of equity, or from borrowings, or fromstrategic partners.  Our future capitalrequirements will depend on many factors, including the scope and progress madein our research and development activities and our clinical trials and the sizeand timing of creating expanded manufacturing capabilities. We may also needadditional funds for possible future strategic acquisitions of businesses,products or technologies complementary to our business. We do not expect togenerate significant revenues for AI-700, other than possible license ormilestone payments, unless or until we or current or potential partners completeclinical trials and receive marketing approval from the applicable regulatoryauthorities. When additional funds are required or, in advance of suchrequirements, we anticipate that funds will be needed, we may raise such fundsfrom time to time through public or private sales of equity or from borrowingsor from strategic partners or we may delay funding of certain developmentactivities which could delay the filing of our AI-700 NDA and thecommercialization of AI-700 which would have a materially adverse impact on ourgrowth plans.  Additional equityfinancing may be dilutive to our stockholders; debt financing, if available,may involve significant cash payment obligations and covenants that restrictour ability to operate as a business; and strategic partnerships may result inroyalties or other terms which reduce our economic potential from productsunder development.

 

**UniversalShelf Registration Statement**

 

We have on filewith the U.S. Securities and Exchange Commission “SEC” a “universal shelf”registration statement on Form S-3 (Registration No. 333-123854) which,when combined with our previously filed universal shelf registration statementon Form S-3, provides for the offer, from time to time, of common stock,preferred stock, debt securities and warrants up to an aggregate of $ $81.3million. This shelf registration statement was declared effective by the SEC onApril 15, 2005. As of the filing of this report, the shelf registrationstatement remains effective and, subject to market conditions and our capitalneeds, and so long as we are then eligible to use the registration statementunder SEC rules, we may again seek to use any remaining availability under theshelf registration statement by making an offering of securities covered forsale under the registration statement. In addition, we may amend our shelfregistration statement or file a new shelf registration statement toincrease our potential access to capital. If we elect to raise additionalcapital using a shelf registration statement, we may use the net proceeds fromthe sale of these securities for general corporate purposes, which may includefunding clinical trials, research and development, regulatory activities andthe qualification of our commercial manufacturing facility in Tewksbury,Massachusetts, acquisitions, including acquisitions of companies, products,intellectual property or other technology, repayment or refinancing of existingindebtedness, investments, capital expenditures, repurchase of our capitalstock and for any other purposes that we may specify in any prospectussupplement. The existence of this shelf registration statement is not intendedto be indicative of any particular financing plan by us. If and when we pursueadditional financing through the issuance of additional equity or debtsecurities, this shelf registration statement is intended to help facilitatesuch transactions.

 

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**Off-BalanceSheet Financing Arrangements**

 

We currently donot have any special purpose entities or off-balance sheet financingarrangements other than operating leases.

 

**ContractualObligations**

 

The followingtable summarizes our contractual obligations as of September 30, 2005 and theeffect such obligations are expected to have on our liquidity and cash flow infuture periods:

 

**Payments Due by Period**

 
| **Contractual Obligations**                        | ** ** | **Total  Obligations  All Years** | ** ** | **2005  Through 2006** | ** ** | **2007  Through 2008** | ** ** | **2009  Through 2010** | ** ** | **After 2010** | ** ** |
|----------------------------------------------------|------------|-----------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|----------------|------------|
| ** **                                         | ** ** | **(in thousands)**                | ** ** |
| Capital lease obligations (including interest)     |       | $                                 | 81         |                   | $          | 22                     |       | $                      | 35         |           | $          | 24 |   | $ | — |   |
| Operating lease  obligations                       |       | 19,479                            |       | 3,403                  |       | 5,911                  |       | 6,022                  |       | 4,142          |       |
| Notes payable  (including interest)                |       | 15,667                            |       | 4,987                  |       | 8,503                  |       | 2,176                  |       | —         |       |
| Intellectual property acquisition cost obligations |       | 6,000                             |       | 3,000                  |       | 3,000                  |       |                   |       |           |       |
| Purchase orders for capital equipment              |       | 980                               |       | 980                    |       | —                 |       | —                 |       | —         |       |
| Purchase orders for leasehold improvements         |       | 2,132                             |       | 2,132                  |       | —                 |       | —                 |       | —         |       |
| Total contractual cash obligations                 |       | $                                 | 44,339     |                   | $          | 14,524                 |       | $                      | 17,449     |           | $          | 8,222 |   | $ | 4,142 |   |

 

With the exceptionof costs in the above table relating to purchase orders, and operating leaseobligations, the amount above are recorded as liabilities in our consolidatedbalance sheet as of September 30, 2005.

 

Our operatinglease obligations relate to our facility leases.

 

A substantialportion of the purchase orders for capital equipment and leasehold improvementsin the table above is needed for expanded manufacturing of AI-700.  As of September 30, 2005, we had outstandingpurchase orders for capital equipment which total approximately$7.3 million. Against these purchase orders we have paid approximately$6.3 million in deposits. The table above reflects the remaining amountsdue on these purchase orders. In 2005, we anticipate expenditures for equipmentpurchases and leasehold improvements to total approximately $32.9 million,including $27.3 million of costs paid during the nine months endedSeptember 30, 2005. This $32.9 million includes approximately$0.5 million in excess of the above reflected contractual obligations.This $32.9 million estimate is approximately $0.5 million less thanwe estimated for 2005 total capital spending in our Quarterly Report for thequarter ended June 30, 2005.

 

Included in ourcapital spending estimates for 2005 are amounts spent throughSeptember 30, 2005 and amounts estimated as remaining to be incurred tocomplete our build-out of a commercial manufacturing facility in Tewksbury,Massachusetts. We have entered into an engineering and construction managementservices agreement with a contractor to perform on our behalf, engineering,design and construction management services in connection with this build-out.The total estimated value of this cost plus percentage fee type contract is$25.8 million. As of September 30, 2005, we have incurredinception-to-date costs of $24.3 million under this contract against which wehave paid $22.2 million.  The contractual obligation table abovereflects the $2.1 million difference between these amounts. The table aboveexcludes $2.0 million of additional costs which were not incurred as ofSeptember 30, 2005 but which we anticipate incurring to complete thebuild-out of this facility. The inclusion of these estimated costs brings thetotal estimated build-out cost, excluding equipment purchases, to $26.3million, or approximately $0.5 million in excess of the current contractamount. The build-out of the facility is substantially complete, with minoritems remaining to be addressed by the contractor. We received an occupancypermit for this facility in October 2005.

 

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**CriticalAccounting Policies and Estimates**

 

Our discussion and analysis of our financial condition and results ofoperations are based on our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets, liabilitiesand expenses. On an on-going basis, we evaluate our estimates and judgments,including those related to accrued expenses, fair valuation of stock related tostock-based compensation and income taxes. We based our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our moresignificant judgments and estimates used in the preparation of our consolidatedfinancial statements.

 

*Revenue.*   We recognize revenue from licensearrangements in accordance with Staff Accounting Bulletin No. 104, RevenueRecognition (“SAB 104”) and FASB Emerging Issue Task Force Issue No. 00-21,Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”).We recognize revenue from license payments not tied to achieving a specificperformance milestone ratably over the period over which we are obligated toperform services. The period over which we are obligated to perform services isestimated based on available facts and circumstances. We recognize revenue fromperformance payments, when such performance is substantially in our control andwhen we believe that completion of such performance is reasonably probable,ratably over the period over which we estimate that we will perform suchperformance obligations. Substantive at-risk milestone payments, which arebased on achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably estimated or assured, are recognized as revenue when themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. We do notrecognize revenue in connection with license arrangements until payments arecollected or due and reasonably assured of being collected. In addition, we donot recognize revenue in circumstances where the arrangement includes a refundprovision until the refund condition is no longer applicable unless, in ourjudgment, the refund circumstances are within our operating control andunlikely to occur.  Payments received inadvance of being recognized as revenue are deferred.

 

We are recognizing collaboration revenue of $12.0million associated with the initial license and performance-based paymentsunder the Nycomed agreement based on an estimated recognition period offorty-two months over which we are obligated to perform services supporting theagreement.  This estimated recognitionperiod may change if available facts and circumstances change.  A change in this estimate could result in asignificant change to the amount of revenue recognized in future periods.  In addition, if the Nycomed collaborationagreement is terminated for reasons other than certain non-performance by us,we would recognize the remainder of the payments we have received or otherwiseexpect to collect over the amortization period at the time of termination. Wewill not recognize revenue associated with the potential $58 million inmilestone-based payments that may be earned under the Nycomed agreement untilthe underlying regulatory and sales milestones are achieved.

 

*Accrued Expenses.*    Aspart of the process of preparing consolidated financial statements we arerequired to estimate accrued expenses. This process involves identifyingservices which have been performed on our behalf and estimating the level ofservice performed and the associated cost incurred for such service as of eachbalance sheet date in our consolidated financial statements. Examples ofestimated expenses for which we accrue include professional service fees, suchas lawyers and accountants, and contract service fees such as amounts paid toclinical monitors, data management organizations and investigators inconjunction with clinical trials, and fees paid to contract manufacturers inconjunction with the production of clinical materials. In connection with suchservice fees, our estimates are most affected by our understanding of thestatus and timing of services provided relative to the actual levels ofservices incurred by such service providers. The majority of our serviceproviders invoice us monthly in arrears for services performed. In the eventthat we do not identify certain costs which have begun to be incurred or weunder- or over-estimate the level of services performed or the costs of suchservices, our reported expenses for such period would be too low or too high.The date on which certain services commence, the level of services performed onor before a given date and the cost of such services are often judgmental. Wemake these judgments based upon the facts and circumstances known to us inaccordance with generally accepted accounting principles.

 

*Stock-Based Compensation and OtherEquity Instruments.*    We have elected tofollow APB Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations, in accountingfor our stock-based compensation plans, rather than the alternative fair valueaccounting method provided for under SFAS No. 123, *Accounting for Stock-Based Compensation*.Accordingly, we have not recorded stock-based compensation expense for stockoptions issued to employees in fixed amounts with exercise prices 

 

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at least equal to thefair value of the underlying common stock on the date of grant. In the notes toour consolidated financial statements we provide pro forma disclosures inaccordance with SFAS No. 123 and related pronouncements. We expect toadopt SFAS No. 123R on January 1, 2006 using the Statement’s modifiedprospective application method. We do not yet have an estimate of the effect onour statements of operations of adopting SFAS No. 123. We account fortransactions in which services are received in exchange for equity instrumentsbased on the fair value of such services received from non-employees or of theequity instruments issued, whichever is more reliably measured, in accordancewith SFAS No. 123 and EITF Issue No. 96-18, *Accounting for Equity Instruments that Are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*. We account for transactions in which we grant warrants inconnection with the issuance of debt in accordance with APB 14, *Accounting for Convertible Debt and Debt Issued withStock Purchase Warrants*. The two factors which most affect chargesor credits to operations related to stock-based compensation are the fair valueof the common stock underlying stock options for which stock-based compensationis recorded and the volatility of such fair value.

 

Accounting forequity instruments granted or sold by us under APB No. 14, APBNo. 25, SFAS No. 123 and EITF No. 96-18 requires fair valueestimates of the equity instrument granted or sold. If our estimates of thefair value of these equity instruments are too high or too low, it would havethe effect of overstating or understating expenses. When equity instruments aregranted or sold in exchange for the receipt of goods or services and the valueof those goods or services can be readily estimated, we use the value of suchgoods or services to determine the fair value of the equity instruments. Whenequity instruments are granted or sold in exchange for the receipt of goods orservices and the value of those goods or services can not be readily estimated,as is true in connection with most stock options and warrants granted to employeesor non-employees, we estimated the fair value of the equity instruments basedupon consideration of factors which we deemed to be relevant at the time usingcost, market and/or income approaches to such valuations. Because shares of ourcommon stock were not publicly traded prior to our initial public offering inOctober 2003, market factors historically considered in valuing stock andstock option grants include comparative values of public companies discountedfor the risk and limited liquidity provided for in the shares we are issuing,pricing of private sales of our convertible preferred stock, prior valuationsof stock grants and the effect of events that have occurred between the time ofsuch grants, economic trends, perspective provided by investment banks and thecomparative rights and preferences of the security being granted compared tothe rights and preferences of our other outstanding equity.

 

*DerivativeLiability.*    The terms of our February2005 convertible preferred stock offering and March 2005 MassDevelopment loanagreement include a dividend make-whole payment feature. This feature isconsidered to be an embedded derivative and is recorded at fair value inaccordance with Statement of Financial Accounting Standards No. 133, Accountingfor Derivative Instruments (SFAS 133). The derivative liability is reduced formake-whole payments triggered upon conversion of the preferred stock as well asdividends declared by our board of director’s, if any, on the convertiblepreferred stock. The changes in the fair value of the derivative financialinstrument are included in Other Income (Expense) in each reporting period.

 

*IncomeTaxes.*    As part of the process ofpreparing our consolidated financial statements we are required to estimate ourincome taxes in each of the jurisdictions in which we operate. This processinvolves us estimating our actual current tax exposure together with assessingtemporary differences resulting from differing treatments of items for tax andaccounting purposes. These differences result in deferred tax assets andliabilities. In addition, as of December 31, 2004, we had federal tax netoperating loss carryforwards of $84.0 million, which expire through 2024.We also have research and development credit carryforwards of $5.3 million.We have recorded a valuation allowance to fully offset against these otherwiserecognizable net deferred tax assets due to the uncertainty surrounding thetiming of the realization of the tax benefit. In the event that we determine inthe future that we will be able to realize all or a portion of its net deferredtax benefit, an adjustment to deferred tax valuation allowance would increasenet income in the period in which such a determination is made. The Tax ReformAct of 1986 contains provisions that may limit the utilization of net operatingloss carryforwards and credits available to be used in any given year in theevent of significant changes in ownership interest, as defined.

 

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**Certain Factors Which May Affect Future Results**

 

*Our operating results andfinancial condition have varied in the past and**may in the future vary significantly depending on a number of factors.Except**for the historical information in thisreport, the matters contained in this**reportinclude forward-looking statements that involve risks and uncertainties.**The following factors, among others, could causeactual results to differ**materially from thosecontained in forward-looking statements made in this**report and presented elsewhere by management from time to time. Suchfactors,**among others, may have amaterial adverse effect upon our business, results of**operations and financial condition.*

 

**Risks Related to Our Company**

 

***We have not generated any product revenue to date, have ahistory of operating losses and our capital resources are limited.***

 

We are focused onproduct development and we have not generated any revenue from commercial salesof our products to date. We have incurred losses each year of our operations.In 2004, we had a net loss available to holders of common stock of$30.0 million, and in the nine months ended September 30, 2005, we had anet loss available to holders of common stock of $34.8 million. At September 30,2005 we had an accumulated deficit of $208.5 million. We expect ourresearch and development, general and administrative and sales and marketingexpenses will increase over the next several years.

 

We expect tocontinue to incur losses and capital expenditures for the foreseeable future.We also anticipate cash out flow from debt repayment and payment of otherobligations. We believe, based on our operating plans, that our existingresources, including scheduled proceeds from Nycomed, will be adequate to fundour planned operations through 2006, or longer if we elect to reduce our rateof spending.  Unless we reduce ourcurrent rate of spending, we will require significant additional funds todevelop products, conduct clinical trials, achieve regulatory approvals,build-out and qualify commercial manufacturing space and, subject to regulatoryapproval, commercially launch AI-700, our other product candidates underdevelopment and future product candidates, which we may raise through public orprivate sales of equity, or from borrowings, or from strategic partners.

 

As a result of ourlimited capital resources, we may elect to delay the funding of certaindevelopment activities, including the filing of our AI-700 for NDA, which wouldresult in a delay in the commercialization of AI-700. Any such delay in thefiling of a NDA or commercialization of AI-700 would have a material adverseimpact on our financial position and business and would likely have a materialadverse effect on the market price of our common stock. To address our capitalneeds, we may elect to raise funds through public or private sales of equity orfrom borrowings or from strategic partners. Additional equity financing, ifavailable, may be dilutive to our stockholders; debt financing, if available,may involve significant cash payment obligations and covenants that restrictour ability to operate as a business; and strategic partnerships, if available,may result in royalties or other terms which reduce our economic potential fromproducts under development. In addition, third parties may attempt to acquireus at valuations our board of directors or stockholders may not findattractive. If our capital resources are not sufficient to fund our plannedoperations for a twelve month period at the time the audit for our 2005 financialresults is complete, our auditor may require a going concern qualification inits audit report be included in our audit report on Form 10-K. Any suchqualification would have a material adverse effect on our ability to raisecapital and would have a material adverse effect on the market price of ourcommon stock.

 

***Weneed to allocate significant amounts of our available capital resources to makepayments on our outstanding indebtedness and equipment lease obligations, ourpatent transfer agreement with Schering Aktiengesellschaft and as dividends onour 6.5% convertible exchangeable preferred stock, which in turn could reduceour financial flexibility and ability to fund other activities***.

 

As of September 30,2005, we had approximately $13.3 million in aggregate principal indebtednessoutstanding, including $68,000 in capital lease obligations. In addition, pursuantto our patent transfer agreement with Schering, we have agreed to pay Schering $3.0 millionin May 2006 and $3.0 million in May 2007. As of September 30, 2005,we had outstanding 900,000 shares of our 6.5% convertible exchangeablepreferred stock, which shares accrue cumulative cash dividends at the annualrate of $3.25 per share, payable quarterly on the first day of March, June,September, and December. These payments will:

 

•                    reducethe availability of our capital to fund our clinical trials for AI-700, thebuild-out and qualification of our commercial manufacturing space in Tewksbury,Massachusetts and for working capital and other general corporate purposes andmay require us, in order to meet these obligations, to delay or reduceexpenditures or forego business opportunities; and

 

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•                    potentially impair our ability to obtainadditional financing, including intended future borrowings against ourequipment financing line with Oxford Finance Corporation.

 

To address our capitalneeds, we may elect to raise funds through public or private sales of equity orfrom borrowings or from strategic partners. Additional equity financing, ifavailable, may be dilutive to our stockholders; debt financing, if available,may involve significant cash payment obligations and covenants that restrictour ability to operate as a business; and strategic partnerships, if available,may result in royalties or other terms which reduce our economic potential fromproducts under development.

 

***If wefail to obtain regulatory approvals for our product candidates underdevelopment, and in particular our lead product candidate AI-700, we will notbe able to generate revenues from the commercialization or sale of our productcandidates.***

 

We must receiveregulatory approval of each of our product candidates before we cancommercialize or sell that product candidate. The pre-clinical laboratorytesting, formulation development, manufacturing and clinical trials of anyproduct candidates we develop independently or in collaboration with thirdparties, as well as the distribution and marketing of these product candidates,are regulated by numerous federal, state and local governmental authorities inthe United States, principally the FDA, and by similar agencies in othercountries. The development and regulatory approval process takes many years,requires the expenditure of substantial resources, is uncertain and subject todelays, and will thus delay our receipt of revenues, if any, from any of ourproduct candidates. We cannot assure you that our clinical trials willdemonstrate the safety and efficacy of any of our product candidates or willresult in marketable products.

 

No product canreceive FDA approval unless human clinical trials show both safety and efficacyfor each target indication in accordance with FDA standards. A number ofcompanies in the pharmaceutical and biotechnology industries have sufferedsignificant setbacks in late stage clinical trials even after achievingpromising results in early stage development. We therefore cannot assure youthat the results from our Phase 2 clinical trials for AI-700 will be predictiveof results obtained in our Phase 3 clinical trials.

 

Many of thepatients in our AI-700 clinical trials have coronary heart disease. As part ofour AI-700 clinical trials, patients will be exposed to potential safety risksassociated with a stress test, including risks associated with apharmacological stressor, and AI-700. Given the nature of the AI-700 clinicaltrials, including administering AI-700 in Phase 3 to larger numbers of at-riskpatients and new clinical sites and administering AI-700 to patients withcoexisting disease, adverse events are expected to be encountered during theclinical trial. Adverse events are also likely to be encountered in clinicaltrials for our other products, which clinical trials also include at-riskpatients. If significant adverse events are detected and these events areattributable to our products, such events could delay, limit or preventregulatory agency approval.

 

Further, dataobtained from pre-clinical and clinical activities are subject to varyinginterpretations that could delay, limit or prevent regulatory agency approval.We cannot assure you that our Phase 3 plan for AI-700 will successfully addressthe concerns of the FDA or that the results of the Phase 3 program willestablish the safety and efficacy of AI-700 sufficiently for us to obtainregulatory approval. We may also encounter delays or rejections based on ourinability to enroll enough patients to complete our clinical trials. We mayalso encounter delays, resulting from the need to enroll more patients than wecurrently plan for in our clinical trials, based on our inability to enroll thecorrect proportion of patients with and without disease that is consistent withour estimated clinical trial enrollment, a higher than expected number of patientsenrolled in the trials who are unevaluable because their nuclear stress orangiography studies are not compliant with trial protocol or a change in thesample size required to meet desired study endpoints. In April 2005, werevised the statistical analysis plan from which we base our patient enrollmentestimates for our AI-700 Phase 3 clinical trials based upon feedback from theFDA and this revision had the effect of increasing the number of patientsestimated to be needed to complete the Phase 3 clinical trials to approximately700 patients based on assumptions that we believed were the most appropriate atthe time. Continued discussions with the FDA could lead to other changesrelating to the Phase 3 clinical trials or related statistical analysis plans.Patient enrollment depends on many factors, including the size and diseaseprevalence of the patient population, the nature of the protocol, the proximityof patients to clinical sites, and the eligibility criteria for the study andthe freedom to operate with respect to intellectual property. During the Phase3 pivotal trials, we are blinded to the disease prevalence of patients in thetrials. However, an independent entity may look at the patient diseaseprevalence data and can, at certain intervals, provide us with feedback as towhether it appears that the number of patients needed to achieve statisticalsignificance is appropriate. This may lead to an increase in the number ofpatients required to complete either or both trials. Separately, an independententity may perform a prospectively planned re-estimation of the patient samplesize required for the trials. This re-estimation may result in the need toenroll more patients. Delays in planned patient enrollment, or the need toenroll more patients, may result in increased costs and delays, which couldhave a harmful effect on our financial position and business.

 

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We may encounterdelays or rejections based on changes in regulatory agency policies orpersonnel during the period in which we develop a drug or the period requiredfor review of any application for regulatory agency approval of a particularcompound. On May 1, 2004, changes went into effect in the regulation ofclinical trials in Europe. Our continuing compliance with these changes couldlead to delays to our clinical trials. We also may encounter delays in theevent we are unable to produce clinical trial material in sufficient quantitiesand of sufficient quality to meet the schedule for our planned clinical trials.In addition, we rely on a number of third parties, such as clinical researchorganizations, to help support the clinical trials by performing independentclinical monitoring, data acquisition and data evaluations. Any failure on thepart of these third parties could delay the regulatory approval process.

 

Failure to obtainregulatory approval or any delay or setback in obtaining regulatory agencyapprovals could:

 

•                    adverselyaffect our ability to market any drugs we develop independently or withcollaborative partners;

 

•                    imposeadditional costs and diminish any competitive advantages that we may attain; or

 

•                    adverselyaffect our ability to generate royalties.

 

In particular, failure toobtain approval or substantial delays in obtaining approval for our leadproduct candidate, AI-700, would delay our receipt of product revenues and wouldhave a material adverse affect our business, financial condition and results ofoperations.

 

We cannot becertain that we will obtain any regulatory approvals in other countries and thefailure to obtain these approvals would have a material adverse affect on ourbusiness, financial condition and results of operations. In order to market ourproducts outside of the United States, we and our current, and potentialfuture, collaborative partners must establish and comply with numerous andvarying regulatory requirements of other countries regarding safety andefficacy. The approval procedures vary among countries and can involveadditional product testing and additional administrative review periods. Thetime required to obtain approval in other countries might differ from thatrequired to obtain FDA approval. The regulatory approval process in othercountries may include all of the risks associated with obtaining FDA approvaldetailed above. Approval by the FDA does not ensure approval by the regulatoryauthorities of other countries. In addition, many countries outside the UnitedStates require a separate review process prior to marketing to determinewhether their national health insurance scheme will pay for newly approvedproducts, as well as the price which may be charged for a product.

 

***Ourproducts, if approved, may fail to achieve market acceptance.***

 

There can be noassurance that any products we successfully develop, if approved for marketing,will achieve market acceptance or generate significant revenues. Each of ourproduct candidates is intended to replace or alter existing therapies orprocedures, and hospitals, physicians or patients may conclude that theseproducts are less safe or effective or otherwise less attractive than theseexisting therapies or procedures. For example, our lead product candidate,AI-700, is a contrast agent for use in ultrasound imaging procedures which willcompete with existing nuclear imaging and stress echocardiography. Hospitals,physicians or patients may prefer these existing procedures to AI-700 enhancedultrasound imaging. If our products do not receive market acceptance for anyreason, it would adversely affect our business, financial condition and resultsof operations.

 

Further, ourcompetitors may develop new technologies or products that are more effective orless costly, or that seem more cost-effective, than our products. We can giveno assurance that hospitals, physicians, patients or the medical community ingeneral will accept and use any products that we may develop.

 

***If wecannot raise additional capital on acceptable terms, we may be unable tocomplete planned clinical trials, obtain regulatory approvals or commercializeour product candidates.***

 

We will requiresubstantial future capital in order to continue to conduct the research anddevelopment, clinical and regulatory activities necessary to bring our productcandidates to market and to establish commercial manufacturing, marketing andsales capabilities. Our future capital requirements will depend on manyfactors, including:

 

•                    theprogress of pre-clinical development and laboratory testing and clinicaltrials;

 

•                    thetiming of construction and size to which we expand our manufacturingcapabilities;

 

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•                    thetime and costs involved in obtaining regulatory approvals;

 

•                    thenumber of product candidates we pursue;

 

•                    thecosts involved in filing and prosecuting patent applications and enforcing ordefending patent claims; and

 

•                    theestablishment of selected strategic alliances and activities required forproduct commercialization.

 

We intend to seekadditional funding through strategic collaborations and may seek fundingthrough private or public sales of our securities or by licensing all or aportion of our technology. This funding may significantly dilute existingstockholders or may limit our rights to our technology.

 

We cannot assureyou that we can obtain additional funding on reasonable terms, or at all. If weraise additional funds by issuing equity securities, our stock price maydecline, our existing stockholders may experience significant dilution, and thenewly issued securities may have rights superior to those of our common stock.If we raise additional funds by issuing debt, we may be subject to limitationson our operations and such debt may have rights senior to the debentures, ifissued. If we cannot obtain adequate funds, we may:

 

•                    terminateor delay clinical trials for one or more of our product candidates;

 

•                    delayour establishment of sales, marketing and/or manufacturing capabilities;

 

•                    curtailsignificant product development programs that are designed to identify newproduct candidates;

 

•                    relinquishrights to our technologies or product candidates; and/or

 

•                    terminateor delay build-out and commissioning of our commercial manufacturing facility.

 

***Claimsor potential claims by other parties that we infringe or have misappropriatedtheir proprietary technology may result in liability for damages, royalties, orother payments, or stop our development and commercialization effortsaltogether.***

 

Competitors andother third parties may initiate patent litigation against us in the UnitedStates or in foreign countries based on existing patents or patents that may begranted in the future. Many of our competitors have obtained patents coveringproducts and processes generally related to our products and processes, andthey may assert these patents against us. Moreover, there can be no assurancethat these competitors have not sought or will not seek additional patents thatmay cover aspects of our technology. As a result, there is a greater likelihoodof a patent dispute than would be expected if our competitors were pursuingunrelated technologies.

 

While we conductpatent searches to determine whether the technologies used in our productsinfringe patents held by third parties, numerous patent applications arecurrently pending and may be filed in the future for technologies generallyrelated to our technologies, including many patent applications that remainconfidential after filing. Due to these factors and the inherent uncertainty inconducting patent searches, there can be no guarantee that we will not violatethird-party patent rights that we have not yet identified.

 

We know of U.S.and foreign patents issued to third parties that relate to aspects of ourproduct candidates. There may also be patent applications filed by these orother parties in the United States and various foreign jurisdictions thatrelate to some aspects of our product candidates, which, if issued, couldsubject us to infringement actions. In particular, we are aware of U.S. andforeign patents owned by third parties, including potential competitors, thatarguably cover aspects of our AI-700 contrast agent. We and several of theseparties have recently been actively engaged in opposing the grant of Europeanpatents with claims that arguably cover aspects of our AI-700 product. Partiesmay contest patents in Europe prior to contesting the counterpart patents inthe United States because of procedural differences between European and U.S.patent laws as well as economic considerations. There is a significant possibilitythat one or more of these third parties will use litigation to assert theirpatents in the United States or Europe.

 

The owners orlicensees of these and other patents may file one or more infringement actionsagainst us. In addition, a competitor may claim misappropriation of a tradesecret by an employee hired from that competitor. Any such infringement ormisappropriation action could cause us to incur substantial costs defending thelawsuit and could distract our management from our business, even if theallegations of infringement or misappropriation are unwarranted. The defense ofmultiple claims could have a disproportionately greater impact. In addition,either in response to or in anticipation of any such infringement ormisappropriation claim, we may enter into commercial agreements with the ownersor licensees of these rights. The terms of these commercial agreements mayinclude substantial payments, including substantial royalty payments onrevenues received by us in connection with the commercialization of ourproducts. These payments could increase our operating losses and reduce ourresources available for development activities. Furthermore, a party makingthis type of claim could secure a judgment that requires us to pay substantialdamages, 

 

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which would increase ouroperating losses and reduce our resources available for development activities.A judgment could also include an injunction or other court order that couldprevent us from making, using, selling, offering for sale or importing ourproducts or prevent our customers from using our products. If a courtdetermined or if we independently concluded that any of our products ormanufacturing processes violated third-party proprietary rights, our clinicaltrials could be delayed and there can be no assurance that we would be able toreengineer the product or processes to avoid those rights, or to obtain alicense under those rights on commercially reasonable terms, if at all.

 

***If weare unable to protect our intellectual property rights, our competitors maydevelop and market products with similar features that may reduce demand forour products, and we may be prevented from establishing collaborativerelationships on favorable terms.***

 

The followingfactors are important to our success:

 

•                    receivingpatent protection for our product candidates;

 

•                    maintainingour trade secrets;

 

•                    notinfringing on the proprietary rights of others; and

 

•                    preventingothers from infringing our proprietary rights.

 

We will be able toprotect our proprietary rights from unauthorized use by third parties only tothe extent that our proprietary rights are covered by valid and enforceablepatents or are effectively maintained as trade secrets.

 

We try to protectour proprietary position by filing U.S. and foreign patent applications relatedto our proprietary technology, inventions and improvements that are importantto the development of our business. Because the patent position ofpharmaceutical companies involves complex legal and factual questions, theissuance, scope and enforceability of patents cannot be predicted withcertainty. Patents, if issued, may be challenged, invalidated or circumvented.Thus, any patents that we own or license from others may not provide anyprotection against competitors. Our pending patent applications, those we mayfile in the future, or those we may license from third parties, may not resultin patents being issued. If issued, they may not provide us with proprietaryprotection or competitive advantages against competitors with similartechnology. Furthermore, others may independently develop similar technologiesor duplicate any technology that we have developed. The laws of many foreigncountries do not protect our intellectual property rights to the same extent asdo the laws of the United States.

 

We also rely ontrade secrets, know-how and technology, which are not protected by patents, tomaintain our competitive position. We try to protect this information byentering into confidentiality agreements with parties that have access to it,such as our corporate partners, collaborators, employees and consultants. Anyof these parties may breach the agreements and disclose our confidentialinformation or our competitors might learn of the information in some otherway. If any trade secret, know-how or other

technology not protectedby a patent were to be disclosed to or independently developed by a competitor,our business and financial condition could be materially adversely affected.

 

***Wemay become involved in lawsuits and administrative proceedings to protect,defend or enforce our patents that would be expensive and time consuming.***

 

In order toprotect or enforce our patent rights, we may initiate patent litigation againstthird parties in the United States or in foreign countries. In addition, we havebeen and continue to be subject to interference or opposition proceedingsconducted in patent and trademark offices challenging the priority of or validityof our patents. The defense of intellectual property rights, including patentrights through lawsuits, interference or opposition proceedings, and otherlegal and administrative proceedings can be costly and can divert our technicaland management personnel from their normal responsibilities. Such costsincrease our operating losses and reduce our resources available fordevelopment activities. An adverse determination of any litigation or defenseproceedings could put one or more of our patents at risk of being invalidated orinterpreted narrowly and could put our patent applications at risk of notissuing.

 

Furthermore,because of the substantial amount of discovery required in connection withintellectual property litigation, there is a risk that some of our confidentialinformation could be compromised by disclosure during this type of litigation.For example, during the course of this kind of litigation and despiteprotective orders entered by the court, confidential information may beinadvertently 

 

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disclosed in the form ofdocuments or testimony in connection with discovery requests, depositions ortrial testimony. This disclosure could materially adversely affect our businessand financial results.

 

***Wehave never manufactured any of our product candidates in commercial quantities,and if we fail to develop an effective manufacturing capability for ourproducts, including our lead product candidate AI-700, we may be unable tocommercialize these products.***

 

We have no experiencein manufacturing our products for commercial use and limited experience indesigning equipment for the manufacture of our products. We are working to start-upand qualify operations at a commercial manufacturing facility in Tewksbury,Massachusetts and to demonstrate that we can produce AI-700 at a commercialmanufacturing scale prior to our filing of a NDA for AI-700 and, subject torequired regulatory approvals, we intend to manufacture AI-700 in this facilityfor commercial use. We can not assure you that we will be able to successfullymanufacture our products in sufficient quantities for commercial sale, orobtain the necessary regulatory approvals for such commercial manufacture, atall or in a timely or economical manner. Our intention to manufacture AI-700 orother products exposes us to the following risks, any of which could delay orprevent the approval of our products by the FDA or corresponding state andforeign agencies, or the commercialization of our products, or result in highercosts or inability to meet demand for AI-700 leading to potential revenue loss,and any of which would have a material adverse impact on our business,financial condition and results of operations.

 

•                    Manufacturersoften encounter difficulties in achieving volume production, quality controland quality assurance. Accordingly, we might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules or tocommercialize our products.

 

•                    Manufacturersare obliged to manufacture in highly controlled environments and to operate inaccordance with FDA and international mandated current good manufacturingpractices, or cGMPs. For our clinical trials we have relied on contractmanufacturers for such facilities and cGMP compliance. In July 2004, weentered into a lease for a facility in Tewksbury, Massachusetts that we are inthe process of converting into a commercial manufacturing facility for AI-700.Creation and qualification of a commercial manufacturing environment requiressignificant expertise and capital resources, including the development ofadvanced manufacturing techniques and process controls and is subject to localand state planning approvals. Manufacturers of pharmaceutical products oftenencounter difficulties in constructing and qualifying new manufacturingfacilities and in production, especially in scaling-up initial production. Afailure within this new facility to establish and follow cGMPs and to documentadherence to such practices may lead to significant delays in the availabilityof material for our NDA filing or commercial production for AI-700 and maydelay or prevent filing or approval of marketing applications for our productsor the ability to continue to manufacture the products. Certain of these delayswould further require us to continue to operate this facility and incur relatedcosts.

 

•                    Manufactureof our product candidates, in preparation for filing a NDA and for commercialproduction, will each initially require and rely on a single commercialmanufacturing site, directly or through a contract manufacturer, without thebackup of a second site that is qualified for commercial manufacture of theproduct. Qualification of another manufacturing site can be expensive and timeconsuming. Prior to using product from a new manufacturing site, we mustdemonstrate to the FDA and corresponding state and foreign agencies that thespecifications for the product are consistent with the specifications for theproduct as it was manufactured at a prior qualified site or we must clinicallyor otherwise demonstrate that the safety and efficacy of the product producedin the new manufacturing site is consistent with the product as it wasmanufactured at the prior site. Demonstrating such consistency may bedifficult, expensive or time consuming. In addition, before we would be able toproduce product for commercial use at a new facility, it will have to undergo apre-approval inspection by the FDA and corresponding state and foreignagencies. Once approved, drug manufacturers are subject to ongoing periodicunannounced inspection by the FDA and corresponding state and foreign agenciesto ensure strict compliance with cGMPs, other government regulations andcorresponding foreign standards. Failure to maintain compliance with cGMP orwith safety or environmental regulations could result in penalties, productrecalls or restrictions on the use of the manufacturing site.

 

Under the terms ofour collaboration agreement with Nycomed, we are responsible for the commercialmanufacture of AI-700 for marketing and sale by Nycomed in Europe. Failure tomanufacture AI-700 in a timely manner or on an economic basis, or in sufficientquantities, could jeopardize our relationship with Nycomed. We do not currentlyhave a European sales force, nor do we have experience with regard to thecommercialization, marketing, sale or distribution of pharmaceutical productsin Europe, and we rely 

 

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entirely on Nycomed forthis expertise. Any termination of our relationship with Nycomed would have amaterial adverse impact on our business, financial condition and results ofoperations.

 

***Wehave removed our AI-700 manufacturing equipment from the facilities of ourthird party contract manufacturer and currently have no facility within whichto manufacture AI-700 until the new commercial manufacturing facility isbuilt-out and qualified or until other arrangements are made.***

 

We have removedour AI-700 manufacturing equipment from the facilities of a third-partycontract manufacturer. We believe that we have sufficient inventory of AI-700clinical trial material to complete our Phase 3 program. However, there can beno assurance that such inventory will prove sufficient or that the inventorywill not get damaged or otherwise disqualified. Currently, we have no facilitywithin which to manufacture AI-700 until the new commercial manufacturingfacility is qualified or until other arrangements are made. If we lacksufficient inventory of AI-700 clinical trial material to complete our Phase 3program or are unable to manufacture sufficient inventory on a timely basis,our Phase 3 program could be delayed and would consequently delay our abilityto commercialize AI-700. These delays could have a material adverse effect onour business, financial condition and results of operations.

 

***Ifthird-party manufacturers of our products fail to devote sufficient time andresources to our concerns, or if their performance is substandard, our clinicaltrials may be delayed and our costs may rise.***

 

We may relysubstantially on third-party contract manufacturers to supply, store anddistribute our potential products for our clinical trials and other developmentneeds. Our reliance on these third-party manufacturers will expose us to thefollowing risks, any of which could delay or prevent the completion of ourclinical trials, the approval of our products by the FDA, or thecommercialization of our products, result in higher costs, or deprive us ofadditional product candidates, and any of such effects would have a materialadverse impact on our business, financial condition and results of operations.

 

•                    Contractmanufacturers often encounter difficulties in achieving volume production,quality control and quality assurance, as well as shortages of qualifiedpersonnel. Accordingly, a manufacturer might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules.

 

•                    Contractmanufacturers are obliged to operate in accordance with FDA-mandated currentgood manufacturing practices, or cGMPs. A failure of these contractmanufacturers to establish and follow cGMPs and to document their adherence tosuch practices may lead to significant delays in the availability of materialfor clinical study and may delay or prevent filing or approval of marketingapplications for our products.

 

•                    Forproduction of clinical trial material for each of our current productcandidates we will initially rely on a single manufacturer. Changing these orfuture manufacturers may be difficult and the number of potential manufacturersis limited. Changing manufacturers may require re-validation of themanufacturing processes and procedures in accordance with FDA-mandated cGMPs.Such re-validation may be costly and time-consuming. It may be difficult or impossiblefor us to find replacement manufacturers on acceptable terms quickly, or atall.

 

•                    Ourcontract manufacturers may not perform as agreed or may not remain in thecontract manufacturing business for the time required to produce, store anddistribute our products successfully. Our manufacturing levels, while importantto us, can represent relatively small fractions of the overall business of mostqualified contract manufacturers. As a result, the contract manufacturers maynot provide us with the attention that we need or may be unwilling to adapt tonecessary changes in our manufacturing requirements.

 

Drug manufacturersare subject to ongoing periodic unannounced inspection by the FDA andcorresponding state and foreign agencies to ensure strict compliance withcGMPs, other government regulations and corresponding foreign standards. Whilewe are obligated to audit the performance of third party contractors, we do nothave control over our third-party manufacturers’ compliance with theseregulations and standards. Failure by our third-party manufacturers or us tocomply with applicable regulations could result in sanctions being imposed onus, including fines, injunctions, civil penalties, failure of the government togrant market approval of drugs, delays, suspension or withdrawal of approvals,seizures or recalls of product, operating restrictions and criminalprosecutions, any of which could significantly and adversely affect ourbusiness.

 

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***Wemay not be able to manufacture our products in commercial quantities, whichwould prevent us from marketing our products.***

 

To date ourproduct candidates have been manufactured in small quantities for pre-clinicaland clinical trials. If any of these product candidates are approved by the FDAor foreign regulatory authorities for commercial sale, we will need tomanufacture them in larger quantities. For AI-700, it is our intention to seekregulatory approval after we have demonstrated that we can manufacture AI-700at a larger batch scale than is being used for clinical trial materials. Wecannot assure you that we will be able to successfully increase themanufacturing capacity or manufacture at a larger batch scale, whether on ourown or in collaboration with third party manufacturers, for any of our productcandidates in a timely or economic manner, or at all. Significant scale-up ofmanufacturing may require certain additional validation studies, which the FDAmust review and approve. If we are unable to successfully increase themanufacturing capacity for a product candidate, the regulatory approval orcommercial launch of that product candidate may be delayed or there may be ashortage in supply of that product candidate. Our product candidates require precise,high-quality manufacturing. Our failure to achieve and maintain these highmanufacturing standards, including controlling the incidence of manufacturingerrors and maintaining reliable product packaging for diverse environmentalconditions, could result in patient injury or death, product recalls orwithdrawals, delays or failures in product testing or delivery, cost overrunsor other problems that could seriously hurt our business.

 

***Materialsnecessary to manufacture our products may not be available, which may delay ourdevelopment and commercialization activities.***

 

Only a fewfacilities manufacture some of the raw materials necessary to manufacture ourproducts. If we need to purchase a raw material that is in limited supply forour clinical trials, or for commercial distribution if we obtain marketingapproval of a product candidate, we cannot assure you that one or moresuppliers would be able to sell us that raw material at the time we need it andon commercially reasonable terms. If we change suppliers for any of thesematerials or any of our suppliers experiences a shutdown or disruption in thefacilities used to produce these materials, due to technical, regulatory orother problems, it could harm our ability to manufacture our products. Our inabilityto obtain required raw materials for any reason could substantially impair ourdevelopment activities or the production, marketing and distribution of ourproducts.

 

***Wehave no experience selling, marketing or distributing our products and nointernal capability to do so.***

 

If we receiveregulatory approval to commence commercial sale of any product, we will facecompetition with respect to commercial sales, marketing and distribution. Theseare areas in which we have no experience. To market any of our productsdirectly, we must develop a direct marketing and sales force with technicalexpertise and supporting distribution capability. Alternatively, we may engagea pharmaceutical or other healthcare company with an existing distributionsystem and direct sales force to assist us. There can be no assurance that wewill successfully establish sales and distribution capabilities either on ourown or in collaboration with third parties or gain market acceptance for ourproducts. To the extent we have or will enter co-promotion or other licensingarrangements, any revenues we receive will depend on the efforts of thirdparties and there can be no assurance that our efforts will succeed.

 

***Wewill establish collaborative relationships, and those relationships may exposeus to a number of risks.***

 

We will rely on anumber of significant collaborative relationships with pharmaceutical or otherhealthcare companies for our manufacturing, research funding, clinicaldevelopment and/or sales and marketing performance. Reliance on collaborativerelationships poses a number of risks, including the following:

 

•                    wecannot effectively control whether our corporate partners will devotesufficient resources to our programs or product candidates;

 

•                    disputesmay arise in the future with respect to the ownership of rights to technologydeveloped with collaborators;

 

•                    disagreementswith collaborators could delay or terminate the research and development,regulatory approval or commercialization of product candidates, or result inlitigation or arbitration;

 

•                    corporatepartners may have considerable discretion in electing whether to pursue thedevelopment of any additional product candidates and may pursue technologies orproducts either on their own or in collaboration with our competitors; and

 

•                    collaboratorswith marketing rights may choose to devote fewer resources to the marketing ofour product candidates than they do to product candidates of their owndevelopment.

 

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In July 2004,we entered into a collaboration, license and supply agreement with Nycomed inwhich we granted Nycomed rights to develop and market AI-700 in Europe. Therecan be no assurance that the regulatory goals, sales targets and otherobjectives of this agreement will be achieved. Failure to achieve these goals,targets and objectives would result in our inability to receive license,milestone, royalty and other payments under this agreement, which would have amaterial adverse impact on our business, financial condition and results ofoperations including, under certain conditions, reduction of royalty rates,delays in regulatory approvals and product sales, penalties and termination ofthe agreement. Under certain provisions of this collaboration agreement, if wefail in any material respect to use all commercially reasonable efforts tocarry out referenced obligations under the agreement, we would be obligated topay Nycomed liquidated damages of up to $12 million. Although we plan tocarry out all of these obligations, which we believe are in our control, therecan be no assurance that termination of this agreement will not occur or thatsuch termination would not result in us incurring liquidated damages of up to$12 million.

 

Given these risks,our current and future collaborative efforts may not be successful. Failure ofthese efforts could delay our product development or impair commercializationof our products, and could have a material adverse effect on our business,financial condition and results of operations.

 

***Competitionin the pharmaceutical industry is intense, and if we fail to competeeffectively our financial results will suffer.***

 

We engage in abusiness characterized by extensive research efforts, rapid developments andintense competition. We cannot assure you that our products will competesuccessfully or that research and development by others will not render ourproducts obsolete or uneconomical. Our failure to compete effectively wouldmaterially adversely affect our business, financial condition and results ofoperations. We expect that successful competition will depend, among otherthings, on product efficacy, safety, reliability, availability, timing andscope of regulatory approval and price. Specifically, we expect important factorswill include the relative speed with which we can develop products, completethe clinical, development and laboratory testing and regulatory approvalprocesses and supply commercial quantities of the product to the market.

 

We expectcompetition to increase as technological advances are made and commercialapplications broaden. In commercializing our initial product candidates and anyadditional products we develop using our HDDS and PDDS technologies, we willface substantial competition from large pharmaceutical, biotechnology and othercompanies, universities and research institutions.

 

•                    AI-700,our ultrasound contrast agent and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear contrast agents thatare approved for use in myocardial perfusion imaging include products marketedby GE Healthcare, Bristol-Myers Squibb and Tyco International. In 2004, thecost of a nuclear stress test was approximately $770 per procedure. Inaddition, GE Healthcare, Bristol-Myers Squibb and Imcor have developedultrasound contrast agents that have been approved by the FDA for use in LeftVentricular Opacification and Endocardial Border Delineation in patients withsuboptimal images, and in the future they may seek to broaden their products toinclude stress echo and myocardial perfusion assessment. Moreover, we are awarethat other companies, such as Bracco, are developing ultrasound contrast agentsfor wall imaging and for radiology applications, and that Point Biomedical isdeveloping an ultrasound contrast agent specifically for myocardial perfusionimaging. In 2004, Point announced that it had recently completed two pivotalPhase 3 trials for this contrast agent and planned to file an NDA with the FDA.Finally, some cardiologists may find it satisfactory to use stress echo withoutcontrast for the detection of coronary heart disease.

 

•                    AI-850,our reformulation of paclitaxel, if approved for marketing and sale, will alsoface intense competition from companies such as American PharmaceuticalPartners, NeoPharm and Sonus Pharmaceuticals (in partnership with Schering AG),which are applying significant resources and expertise to developingreformulations of paclitaxel for intravenous delivery.  American Pharmaceutical Partners has receivedFDA approval and is selling their product. Other companies, such as CellTherapeutics, are developing new chemical entities that involve paclitaxelconjugated, or chemically bound, to another chemical.

 

•                    AI-128,our sustained release formulation of an asthma drug, if approved for marketingand sale, will also face intense competition. Companies such as Alkermespossess technology that may be suitable for sustained release pulmonary drugdelivery and may have competitive programs that have not been publiclyannounced or may decide to begin such programs in the future. In addition,large pharmaceutical companies that market FDA-

 

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approvedasthma drugs may be developing sustained release versions of their asthma drugsthat would compete with our product candidates.

 

Relative to us,most of our competitors have substantially greater capital resources, researchand development staffs, facilities and experience in conducting clinical trialsand obtaining regulatory approvals, as well as in manufacturing and marketingpharmaceutical products. Many of our competitors may achieve productcommercialization or patent protection earlier than we will.

 

Furthermore, webelieve that some of our competitors have used, and may continue to use,litigation to gain a competitive advantage. Finally, our competitors may usedifferent technologies or approaches to the development of products similar tothe products we are seeking to develop.

 

***If weare unable to retain key personnel and hire additional qualified scientific,sales and marketing, and other personnel, we may not be able to successfullyachieve our goals.***

 

We depend on theprincipal members of our scientific and management staff. The loss of theseprincipal members’ services might significantly delay or prevent theachievement of research, development or business objectives and couldmaterially adversely affect our business, financial condition and results ofoperations. We do not maintain key person life insurance on any of theseprincipal members. We do not have employment contracts with any of theseprincipal members.

 

Our successdepends, in large part, on our ability to attract and retain qualifiedscientific and management personnel such as these individuals. We face intensecompetition for such personnel and consultants. We cannot assure you that wewill attract and retain qualified management and scientific personnel in thefuture.

 

Further, we expectthat our potential expansion into areas and activities requiring additionalexpertise, such as further clinical trials, governmental approvals, commercialmanufacturing and marketing, will place additional requirements on ourmanagement, operational and financial resources. We expect these demands willrequire an increase in management and scientific personnel and the developmentof additional expertise by existing management personnel. The failure toattract and retain such personnel or to develop such expertise could materiallyadversely affect prospects for our success.

 

***Weexpect to develop international operations that will expose us to additionalbusiness risks.***

 

We expect, whetherdirectly or through collaborative relationships, to develop operations outsidethe United States in order to market and distribute our products. Regardless ofthe extent to which we seek to develop these operations ourselves or incollaboration with others, we cannot be sure that our international efforts willbe successful. Any expansion into international markets will require additionalresources and management attention and will subject us to new business risks.These risks could lower the prices at which we can sell our products orotherwise have an adverse effect on our operating results. Among the risks webelieve are most likely to affect any international operations are:

 

•                    differentregulatory requirements for approval of our product candidates;

 

•                    dependenceon local distributors;

 

•                    longerpayment cycles and problems in collecting accounts receivable;

 

•                    adversechanges in trade and tax regulations;

 

•                    theabsence or significant lack of legal protection for intellectual propertyrights;

 

•                    politicaland economic instability; and

 

•                    currencyrisks.

 

**Risks Related to Our Industry**

 

***Evenif we obtain marketing approval, our products will be subject to ongoingregulatory review.***

 

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If regulatoryapproval of a product is granted, such approval may be subject to limitationson the indicated uses for which the product may be marketed or containrequirements for costly, post-marketing follow-up studies. As to products forwhich marketing approval is obtained, the manufacturer of the product and themanufacturing facilities will be subject to continual review and periodicinspections by the FDA and other regulatory authorities. In addition, thelabeling, packaging, adverse event reporting, storage, advertising, promotionand record keeping related to the product will remain subject to extensiveregulatory requirements. The subsequent discovery of previously unknownproblems with the product, manufacturer or facility may result in restrictionson the product or the manufacturer, including withdrawal of the product fromthe market. We may be slow to adapt, or we may never adapt, to changes inexisting requirements or adoption of new requirements or policies.

 

If we fail tocomply with applicable regulatory requirements, we may be subject to fines,suspension or withdrawal of regulatory approvals, product recalls, seizure ofproducts, operating restrictions and criminal prosecution.

 

***Marketacceptance of our products will be limited if users of our products are unableto obtain adequate reimbursement from third-party payors.***

 

Government healthadministration authorities, private health insurers and other organizationsgenerally provide reimbursement for products like our product candidates, andour commercial success will depend in part on these third-party payors agreeingto reimburse patients for the costs of our products. Even if we succeed inbringing any of our proposed products to market, we cannot assure you thatthird-party payors, in the United States, Europe and other markets that we maypursue, will consider our products cost-effective or provide reimbursement inwhole or in part for their use or agree to the proposed price.

 

Significantuncertainty exists as to the reimbursement status of newly approved health careproducts. Each of our product candidates is intended to replace or alterexisting therapies or procedures. These third-party payors may conclude thatour products are less safe, effective or cost-effective than these existingtherapies or procedures. Therefore, third-party payors may not approve ourproducts for reimbursement.

 

If third-partypayors do not approve our products for reimbursement or fail to reimburse themadequately, sales will suffer as some physicians or their patients will opt fora competing product that is approved for reimbursement or is adequatelyreimbursed. Even if third-party payors make reimbursement available, thesepayors’ reimbursement policies may adversely affect the ability of us and ourpotential collaborators to sell our products on a profitable basis.

 

Moreover, the trendtoward managed healthcare in the United States, the growth of organizationssuch as health maintenance organizations, and legislative proposals to reformhealthcare and government insurance programs could significantly influence thepurchase of healthcare services and products, resulting in lower prices andreduced demand for our products which could adversely affect our business,financial condition and results of operations.

 

In addition,legislation and regulations affecting the pricing of pharmaceuticals may changein ways adverse to us before or after the FDA or other regulatory agenciesapprove any of our proposed products for marketing. While we cannot predict thelikelihood of any of these legislative or regulatory proposals, if anygovernment or regulatory agencies adopt these proposals they could materiallyadversely affect our business, financial condition and results of operations.

 

***Wemay be required to defend lawsuits or pay damages in connection with thealleged or actual harm caused by our products or product candidates.***

 

We face aninherent business risk of exposure to product liability claims in the eventthat the use of our products is alleged to have resulted in harm to others.This risk exists in clinical trials as well as in commercial distribution. Inaddition, the pharmaceutical and biotechnology industries in general have beensubject to significant medical malpractice litigation. We may incur significantliability if product liability or malpractice lawsuits against us are successful.Furthermore, product liability claims, regardless of their merits, could becostly and divert our management’s attention from other business concerns, oradversely affect our reputation and the demand for our products. Although wemaintain product liability insurance, we cannot be certain that this coveragewill be adequate or that it will continue to be available to us on acceptableterms.

 

***Rapidtechnological change could make our products obsolete.***

 

Pharmaceuticaltechnologies have undergone rapid and significant change. We expect thatpharmaceutical technologies will continue to develop rapidly. Our future willdepend in large part on our ability to maintain a competitive position withrespect to these 

 

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technologies. Anycompounds, products or processes that we develop may become obsolete before werecover any expenses incurred in connection with their development. Rapidtechnological change could make our products obsolete, which could materiallyadversely affect our business, financial condition and results of operations.

 

***Ourproducts involve the use of hazardous materials, and as a result we are exposedto potential liability claims and to costs associated with complying with lawsregulating hazardous waste.***

 

Our research anddevelopment activities involve the use of hazardous materials, includingchemicals and biological materials. We believe that our procedures for handlinghazardous materials comply with federal and state regulations. However, therecan be no assurance that accidental injury or contamination from thesematerials will not occur. In the event of an accident, we could be held liablefor any damages, which could exceed our available financial resources. Thisliability could materially adversely affect our business, financial conditionand results of operations.

 

We are subject tofederal, state and local laws and regulations governing the use, manufacture,storage, handling and disposal of hazardous materials and waste products, andwe spent approximately $30,500 during the fiscal year ended December 31,2004 to dispose of these hazardous materials and waste products. We may berequired to incur significant costs to comply with environmental laws andregulations in the future that could materially adversely affect our business,financial condition and results of operations.

 

**Risks Related to Our Common Stock**

 

***Weexpect that our stock price will fluctuate significantly.***

 

We completed ourinitial public offering in October 2003. Prior to this offering, you couldnot buy or sell our common stock publicly. After this offering, the averagedaily trading volume for our common stock has been relatively low. An activepublic market for our common stock may not continue to develop or be sustained.The stock market, particularly in recent years, has experienced significantvolatility particularly with respect to pharmaceutical and biotechnologystocks. The volatility of pharmaceutical and biotechnology stocks often doesnot relate to the operating performance of the companies represented by thestock. Factors that could cause this volatility in the market price of ourcommon stock include:

 

•                    announcementsof the introduction of new products by us or our competitors;

 

•                    marketconditions in the pharmaceutical and biotechnology sectors;

 

•                    rumorsrelating to us or our competitors;

 

•                    litigationor public concern about the safety of our potential products;

 

•                    ourquarterly operating results;

 

•                    deviationsin our operating results from the estimates of securities analysts; and

 

•                    FDAor international regulatory actions.

 

The market priceof our common stock may also fluctuate in response to the exercise by us ofrights under the terms of our 6.5% convertible exchangeable preferred stock.For example, we may elect to automatically convert the preferred stock if ourcommon stock price has exceeded 150% of the conversion price of the preferredstock for at least 20 trading days during a 30-day trading period ending withinfive trading days prior to the notice of automatic conversion. There is a riskof fluctuation in the price of our common stock between the time when we mayfirst elect to automatically convert the preferred stock and the automaticconversion date. These fluctuations may adversely affect the value of ourcommon stock.

 

***Ourcontrolling equity holders may have conflicts of interests with us or you inthe future.***

 

As of September30, 2005, and based on information provided to us by such entities: QuakerCapital Management Corporation and its affiliates will beneficially ownapproximately 12% of our outstanding common stock; Bank of America Corporationand its affiliates will beneficially own approximately 9% of our outstandingcommon stock; The Baupost Group LLC will beneficially own approximately 9% ofour outstanding common stock; Mr. Peter David Boone will beneficially ownapproximately 8% of our 

 

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outstanding common stock;and Polygon Investment Partners LLP and its affiliates will beneficially ownapproximately 5% of our outstanding common stock. Collectively these investorswill control approximately 44% of our common stock. These investors,particularly if they were to act together as a concentrated group, could exertinfluence over the election of our directors, direct our policies andoperations, including future issuances of common stock or other securities, thepayments of dividends, if any, on our common stock, the incurrence of debt byus, amendments to our certificate of incorporation and bylaws and entering intoof extraordinary transactions, and their interests, as a concentrated group,may not in all cases be aligned with your interests. This concentration ofownership among a small number of investors may make it more difficult forother stockholders to influence matters requiring stockholder approval and mayhave the effect of delaying, preventing or deterring a change in control of ourcompany, thereby possibly depriving our stockholders of an opportunity toreceive a premium for their common stock as part of any sale or acquisition.

 

***Ourcommon stock is junior to our preferred stock with respect to the right toreceive payments in the event of a dissolution, liquidation or winding up ofAcusphere.***

 

InFebruary 2005, we issued and sold 900,000 shares of our 6.5% convertibleexchangeable preferred stock. As of November 9, 2005, 860,000 of these sharesof preferred stock are outstanding. The preferred stock is senior to the commonstock as to liquidation. In the event of our voluntary or involuntarydissolution, liquidation or winding up of Acusphere, holders of our preferredstock will receive a liquidation preference in an amount equal to $50 pershare, plus all accrued and unpaid dividends through the distribution date.Only after holders of the preferred stock have received their liquidationpreference and any accrued and unpaid dividends will we distribute assets, ifany are remaining, to our common stock holders.

 

***Wemay be the subject of securities class action litigation due to future stockprice volatility.***

 

In the past, whenthe market price of a stock has been volatile, holders of that stock have ofteninstituted securities class action litigation against the company that issuedthe stock. If any of our stockholders brought a lawsuit against us, we couldincur substantial costs defending the lawsuit. The lawsuit could also divertthe time and attention of our management.

 

***Futuresales of common stock by our existing stockholders may cause our stock price tofall.***

 

The market priceof our common stock could decline as a result of sales by our existingstockholders of shares of common stock in the market, or the perception thatthese sales could occur. These sales might also make it more difficult for usto sell equity securities at a time and price that we deem appropriate. As of thedate of this report we have approximately 21,413,143 shares of common stockoutstanding and 860,000 shares of convertible preferred stock outstanding thatare convertible into approximately 6.3 million shares of our common stock, plusup to a maximum of approximately 1.9 million additional shares of our commonstock issuable at our option in satisfaction of the maximum dividend make-whole payment on these shares of preferred stock. All of the shares of commonstock issuable upon conversion of our preferred stock will be freely tradablewithout restriction under the federal securities laws unless purchased by ouraffiliates.

 

***Theterms of our outstanding shares of preferred stock may restrict our ability toraise additional capital or hamper or prevent an acquisition of us.***

 

InFebruary 2005 we issued and sold 900,000 shares of our 6.5% convertibleexchangeable preferred stock. As of the date of this report, 860,000 of theseshares of preferred stock are outstanding. In the event of our voluntary orinvoluntary dissolution, liquidation or winding up of Acusphere, holders of ourpreferred stock will receive a liquidation preference in an amount equal to $50per share, plus all accrued and unpaid dividends through the distribution date.Only after holders of the preferred stock have received their liquidationpreference and any accrued and unpaid dividends will we distribute assets, ifany are remaining, to our common stock holders. Without the vote or consent ofthe holders of at least a majority of the shares of preferred stock, we can notauthorize or sell any equity security that ranks senior to the preferred stockas to dividends or distributions of assets upon liquidation, dissolution orwinding up of Acusphere. As a result of this liquidation preference, it may bedifficult for us to raise additional capital through the sale of common stockor junior preferred stock on acceptable terms, or at all.

 

In addition,without the vote or consent of the holders of at least a majority of the sharesof preferred stock we may not effect a consolidation or merger with anotherentity unless the preferred stock that remains outstanding and its rights,privileges and preferences are unaffected or are converted into or exchangedfor preferred stock of the surviving entity having rights, preferences andlimitations substantially similar, but no less favorable, to the convertiblepreferred stock. This provision could hamper a third party’s acquisition of usor discourage a third party from attempting to acquire control of us via amerger.

 

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***Undersome circumstances, the holders of our outstanding shares of preferred stockmay be entitled to elect some of the directors of Acusphere.***

 

InFebruary 2005 we issued and sold 900,000 shares of our 6.5% convertibleexchangeable preferred stock. As of November 9, 2005, 860,000 of these sharesof preferred stock are outstanding. Cumulative dividends accrue on ourpreferred stock at an annual rate of $3.25 per share, payable quarterly on thefirst day of March, June, September and December, commencing June 1, 2005.Any dividends must be declared by our board of directors and must come fromfunds that are legally available for dividend payments. If we have not paiddividends on the preferred stock in an aggregate amount equal to at least sixquarterly dividends whether or not consecutive, we must increase the size ofour board of directors by two additional directors. After this time, and for solong as these dividends remain due and unpaid, holders of the preferred stock,voting separately as a class with holders of preferred stock ranking on thesame basis as to dividends having like voting rights, will be entitled to electtwo additional directors at any meeting of stockholders at which directors areto be elected. These directors will be appointed to classes on the board asdetermined by our board of directors. These voting rights will terminate whenwe have declared and either paid or set aside for payment all accrued andunpaid dividends. The terms of office of all directors so elected willterminate immediately upon the termination of these voting rights.

 

***Provisionsof Delaware law or our charter documents could delay or prevent an acquisitionof us, even if the acquisition would be beneficial to our stockholders, andcould make it more difficult for you to change management.***

 

Provisions ofDelaware law or our charter or by-laws could hamper a third party’s acquisitionof us, or discourage a third party from attempting to acquire control of us.Stockholders who wish to participate in these transactions may not have theopportunity to do so. These provisions could also limit the price thatinvestors might be willing to pay in the future for shares of our common stock.Further, these provisions make it more difficult for stockholders to change thecomposition of our board of directors in any one year.

 

These provisionsinclude:

 

•                    aprovision allowing us to issue preferred stock with rights senior to those ofthe common stock without any further vote or action by the holders of thecommon stock;

 

•                    theexistence of a staggered board of directors in which there are three classes ofdirectors serving staggered three-year terms, thus expanding the time requiredto change the composition of a majority of directors and potentiallydiscouraging someone from making an acquisition proposal for us;

 

•                    theby-laws’ requirement that stockholders provide advance notice when nominatingour directors;

 

•                    theinability of stockholders to convene a stockholders’ meeting without thechairperson of the board, the chief executive officer, the president or amajority of the board of directors first calling the meeting; and

 

•                    theapplication of Delaware law prohibiting us from entering into a businesscombination with the beneficial owner of 15% or more of our outstanding votingstock for a period of three years after the 15% or greater owner first reachedthat level of stock ownership, unless we meet specified criteria.

 

***Wehave never paid dividends on our common stock, and we do not anticipate payingany cash dividends on our common stock in the foreseeable future.***

 

We have paid nocash dividends on our common stock to date and, other than cash dividends paid onour preferred stock, we currently intend to retain our future earnings, if any,to fund the development and growth of our businesses. In addition, the terms ofany future debt or credit facility may preclude us from paying these dividends.As a result, capital appreciation, if any, of our common stock will be yoursole source of gain for the foreseeable future.

 

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**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

We have not usedderivative financial instruments for speculation or trading purposes. However,we are exposed to market risk related to changes in interest rates. Our currentpolicy is to maintain an investment portfolio consisting mainly of U.S. moneymarket and government-grade securities, directly or through managed funds, withmaturities of one year or less. Our cash is deposited in and invested throughhighly rated financial institutions in North America. Our cash equivalents aresubject to interest rate risk and will fall in value if market interest ratesincrease. If market interest rates were to increase immediately and uniformlyby 10% from levels at September 30, 2005, we estimate that the fair value ofour investment portfolio would decline by an immaterial amount. We currentlyhave the ability to hold our fixed income investments until maturity, andtherefore we do not expect our operating results or cash flows to be affectedto any significant degree by the effect of a change in market interest rates onour investments. Interest rates on our outstanding borrowings are at fixedrates of interest and, therefore, we do not expect our operating results orcash flows to be affected to any significant degree by the effect of a changein market interest rates on our outstanding borrowing.

 

**Effects of Inflation**

 

Our assets areprimarily monetary, consisting of cash, and cash equivalents. Because of theirliquidity, these assets are not directly affected by inflation. We also believethat we have intangible assets in the value of our technology. In accordancewith generally accepted accounting principles, we have not capitalized thevalue of this intellectual property on our consolidated balance sheet. Due tothe nature of this intellectual property, we believe that these intangibleassets are not affected by inflation. Because we intend to retain and continueto use our equipment, furniture and fixtures and leasehold improvements, webelieve that the incremental inflation related to replacement costs of suchitems will not materially affect our operations. However, the rate of inflationaffects our expenses, such as those for employee compensation and contractservices, which could increase our level of expenses and the rate at which weuse our resources.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

As of September30, 2005 (the “Evaluation Date”), our management, with the participation of ourChief Executive Officer and our Senior Vice President and Chief FinancialOfficer, evaluated the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15(b) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”). Based upon that evaluation, our ChiefExecutive Officer and our Senior Vice President and Chief Financial Officerconcluded that, as of the Evaluation Date, our disclosure controls andprocedures were effective in ensuring that material information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, including ensuringthat such material information is accumulated and communicated to our management,including our Chief Executive Officer and our Senior Vice President and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

**Internal Control Over Financial Reporting**

 

During the periodcovered by this report, there have been no changes in our internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

None

 

**ITEM 2. CHANGES IN SECURITIES,USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY INSTRUMENTS**

 

None

 

**ITEM 3. DEFAULTS UPON SENIORSECURITIES**

 

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None

 

**ITEM 4. SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5. OTHER INFORMATION**

 

None

 

**ITEM 6.EXHIBITS**

 

List of exhibits:

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                   | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| 31.1                |       | Rule 13a-14(a) /  15d-14(a) Certification |       |
| 31.2                |       | Rule 13a-14(a) /  15d-14(a) Certification |       |
| 32.1                |       | Section 1350  Certifications              |       |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized on this 10th day of November 2005.

 

 
|     | ACUSPHERE, INC. |                                                                                                                                   |
|----------|-----------------|----------------------------------------------------------------------------------------------------------------------------------------|
|     |            |                                                                                                                                   |   |
|     | By:             | /s/ Sherri C. Oberg                                                                                                                    |   |
|     |            | Sherri C. Oberg                                                                                                                        |   |
| * * |            | *President and Chief Executive Officer*                                                                                                |   |
|     |            |                                                                                                                                   |   |
|     | By:             | /s/ John F. Thero                                                                                                                      |   |
|     |            | John F. Thero                                                                                                                          |   |
| * * | * *        | *Senior Vice President and Chief Financial Officer  (Principal Financial*  *and Accounting Officer  and Duly Authorized Officer)* |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                   | ** ** |
|---------------------|------------|-------------------------------------------|------------|
| 31.1                |       | Rule 13a-14(a) /  15d-14(a) Certification |       |
| 31.2                |       | Rule 13a-14(a) /  15d-14(a) Certification |       |
| 32.1                |       | Section 1350  Certifications              |       |

 

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